FIN310 Class Web Page, Fall ' 20
Instructor: Maggie Foley
Jacksonville University
Weekly SCHEDULE, LINKS, FILES and Questions
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Coverage, HW, Supplements -
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References
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Chapter
1, 2 |
Discussion: How to pick stocks (finviz.com) Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar IPO schedule: http://www.marketwatch.com/tools/ipo-calendar Chapter 1 Introduction Introduction to
Capital Markets - ION Open Courseware (Video)
Note: Flow of funds describes the
financial assets flowing from various sectors through financial
intermediaries for the purpose of buying physical or financial assets. *** Household,
non-financial business, and our government Financial institutions
facilitate exchanges of funds and financial products. *** Building blocks of a
financial system. Passing and transforming funds and risks during
transactions. *** Buy and sell, receive and
deliver, and create and underwrite financial products. *** The transferring of funds
and risk is thus created. Capital utilization for individual and for the
whole economy is thus enhanced. For class discussion: 1. What is the business model of each
player in the above graph? 2. Which player is the most important one
in the financial market? 3. Can anyone of them be removed from the
market? Chapter 1
ppt
1. What are the six parts of the financial markets
Money: · To pay for purchases and store wealth
(fiat money, fiat currency) What is Bitcoin for BEGINNERS in 7-Min. & Bitcoin Explained | What
is Cryptocurrency Explained 2019
Financial Instruments: · To transfer resources from savers to
investors and to transfer risk to those best equipped to bear it. Where do student loans go? (video)
An Introduction to Securitized Products: Asset-Backed Securities (ABS)
(video)
Financial Markets: · Buy and
sell financial instruments · Channel
funds from savers to investors, thereby promoting economic efficiency · Affect
personal wealth and behavior of business firms. Example? Financial Institutions. · Provide
access to financial markets, collect information & provide services · Financial
Intermediary: Helps get funds from savers to investors Central Banks · Monitor
financial Institutions and stabilize the economy Regulatory Agencies · To provide
oversight for financial system. The role of financial regulation (Video) - Do
you agree with her?
2. What
are the five core principals of finance
3. What
is stock?
4. Why
do we need stock exchanges? · Transparency · Anonymous · Guarantee
and settlement · Regulated 5. What
is high frequency trading? pros and cons Videos High Frequency Trading (video)
How high frequency trading works (video)
By
PRABLEEN BAJPAI Updated
Sep 21, 2014 Secrecy, Strategy and Speed are the terms that best define high
frequency trading (HFT) firms and indeed, the financial industry at large as
it exists today. HFT
firms are secretive about their
ways of operating and keys to success. The important people associated with
HFT have shunned limelight and preferred to be lesser known, though that's
changing now. The
firms in the HFT business operate through multiple strategies to trade and
make money. The strategies include
different forms of arbitrage – index arbitrage, volatility arbitrage,
statistical arbitrage and merger arbitrage along with global macro,
long/short equity, passive market making, and so on. HFT
rely on the ultra fast speed of
computer software, data access (NASDAQ TotalView-ITCH, NYSE OpenBook, etc) to
important resources and connectivity with minimal latency (delay). Let’s
explore some more about the types of HFT firms, their strategies to make
money, major players and more. HFT
firms generally use private money, private technology and a number of private
strategies to generate profits. The high frequency trading firms can be
divided broadly into three types. The
most common and biggest form of HFT firm is the independent proprietary firm.
Proprietary trading (or "prop
trading") is executed with the firm’s own money and not that of
clients. LIkewise, the profits are for the firm and not for external clients. Some
HTF firms are a subsidiary part of a broker-dealer firm. Many of the regular
broker-dealer firms have a sub section known as proprietary trading desks,
where HFT is done. This section is separated from the business the firm does
for its regular, external customers. Lastly,
the HFT firms also operate as hedge funds. Their main focus is to profit from
the inefficiencies in pricing across securities and other asset categories
using arbitrage. Prior
to the Volcker Rule, many
investment banks had segments dedicated to HFT. Post-Volcker, no commercial
banks can have proprietary trading desks or any such hedge fund investments.
Though all major banks have shut down their HFT shops, a few of these banks
are still facing allegations about possible HFT-related malfeasance conducted
in the past. How Do They Make Money? There
are many strategies employed by the propriety traders to make money for their
firms; some are quite commonplace, some are more controversial. These firms trade from both sides i.e.
they place orders to buy as well as sell using limit orders that are above
the current market place (in the case of selling) and slightly below the
current market price (in the case of buying). The difference between the two
is the profit they pocket. Thus these firms indulge in “market making” only to make
profits from the difference between the bid-ask spread. These transactions
are carried out by high speed computers using algorithms. Another
source of income for HFT firms is that they get paid for providing liquidity by the Electronic Communications
Networks (ECNs) and some exchanges. HFT firms play the role of market
makers by creating bid-ask spreads,
churning mostly low priced, high volume stocks (typical favorites for HFT)
many times in a single day. These firms hedge the risk by squaring off the
trade and creating a new one. Another
way these firms make money is by looking for price discrepancies between securities on different exchanges or
asset classes. This strategy is called statistical arbitrage, wherein a
proprietary trader is on the lookout for temporary inconsistencies in prices
across different exchanges. With the help of ultra fast transactions, they
capitalize on these minor fluctuations which many don’t even get to notice. HFT
firms also make money by indulging in momentum
ignition. The firm might aim to cause a spike in the price of a stock by
using a series of trades with the motive of attracting other algorithm
traders to also trade that stock. The instigator of the whole process knows
that after the somewhat “artificially created” rapid price movement, the
price reverts to normal and thus the trader profits by taking a position
early on and eventually trading out before it fizzles out. The Players The
HFT world has players ranging from small firms to medium sized companies and
big players. A few names from the industry (in no particular order) are
Automated Trading Desk (ATD), Chopper Trading, DRW Holdings LLC, Tradebot
Systems Inc., KCG Holdings Inc. (merger of GETCO and Knight Capital),
Susquehanna International Group LLP (SIG), Virtu Financial, Allston Trading
LLC, Geneva Trading, Hudson River Trading (HRT), Jump Trading, Five Rings
Capital LLC, Jane Street, etc. Risks The
firms engaged in HFT often face risks
related to software anomaly, dynamic market conditions, as well as
regulations and compliance. One of the glaring instances was a fiasco
that took place on August 1, 2012 which brought Knight Capital Group close to
bankruptcy--It lost $400 million in less than an hour after markets opened
that day. The “trading glitch,” caused
by an algorithm malfunction, led to erratic trade and bad orders across
150 different stocks. The company was eventually bailed out. These companies
have to work on their risk management since they are expected to ensure a lot
of regulatory compliance as well as tackle operational and technological
challenges. The Bottom Line The
firms operating in the HFT industry have earned a bad name for themselves because of their secretive ways of doing
things. However, these firms are slowly shedding this image and coming
out in the open. The high frequency trading has spread in all prominent
markets and is a big part of it. According
to sources, these firms make up just about 2% of the trading firms in the
U.S. but account for around 70% of the trading volume. The HFT firms have
many challenges ahead, as time and again their strategies have been
questioned and there are many proposals which could impact their business
going forward. 6. What is flash crash? (refer to the two
articles on the right) Flash crash From Wikipedia, the free encyclopedia A flash crash is a very
rapid, deep, and volatile fall in security prices occurring within an extremely
short time period. A flash crash frequently stems from trades executed
by black-box trading, combined with high-frequency trading, whose speed
and interconnectedness can result in the loss and recovery of billions of
dollars in a matter of minutes and seconds. Occurrences The Flash Crash This type of event occurred on May 6,
2010. A
$4.1 billion trade on the New York Stock Exchange (NYSE) resulted
in a loss to the Dow Jones Industrial Average of
over 1,000 points and then a rise to approximately previous value, all
over about fifteen minutes. The mechanism causing the event has been heavily
researched and is in dispute. On April 21, 2015, the U.S. Department of
Justice laid "22 criminal counts, including fraud and market
manipulation" against Navinder Singh Sarao, a
trader. Among the charges included was the use of spoofing algorithms. 2017 Ethereum Flash Crash On June 22, 2017, the price of Ethereum, the
second-largest digital cryptocurrency, dropped from more than $300 to as low
as $0.10 in minutes at GDAX exchange. Suspected for market manipulation
or an account takeover at first, later investigation by GDAX claimed no
indication of wrongdoing. The crash was triggered by a multimillion-dollar
selling order which brought the price down, from $317.81 to $224.48, and
caused the following flood of 800 stop-loss and margin funding liquidation orders,
crashing the market. British pound flash crash On October 7, 2016, there was a flash
crash in the value of sterling, which dropped more than 6% in two minutes
against the US dollar. It was the pound's lowest level against the dollar
since May 1985. The pound recovered much of its value in the next few
minutes, but ended down on the day's trading, most likely due to market
concerns about the impact of a "hard Brexit"—a more complete break
with the European Union following Britain's 'Leave' referendum
vote in June. It was initially speculated that the flash crash may have been due to
a fat-finger
trader error or an algorithm reacting to negative news articles
about the British Government's European policy. FLASH
CRASH! Dow Jones drops 560 points in 4 Minutes! May 6th 2010 (video)
Flash Crash 2010: Trader Relives Nightmare Three Years
Later (video)
Flash Crash: Can Only One Trader Be Responsible? (video)
What Is High-Frequency Trading? Finance, Algorithms,
Software, Strategies, Firms (2014) (Video, optional)
THE HUMMINGBIRD PROJECT Clips + Trailer (2019) (video)
Flash
Crash 2010 - VPRO documentary – 2011 (video, optional)
|
The World of High-Frequency
Algorithmic Trading In
the last decade, algorithmic trading (AT) and high-frequency trading (HFT)
have come to dominate the trading world, particularly HFT. During 2009-2010,
more than 60% of U.S. trading was attributed to HFT, though that percentage
has declined in the last few years.1 Here’s a look into the world of algorithmic and high-frequency
trading: how they're related, their benefits and challenges, their main users
and their current and future state. High-Frequency Trading – HFT Structure First,
note that HFT is a subset of algorithmic trading and, in turn, HFT includes
Ultra HFT trading. Algorithms essentially work as middlemen between buyers
and sellers, with HFT and Ultra HFT being a way for traders to capitalize on infinitesimal price discrepancies that
might exist only for a minuscule period. Computer-assisted
rule-based algorithmic trading uses dedicated programs that make automated
trading decisions to place orders. AT
splits large-sized orders and places these split orders at different times
and even manages trade orders after their submission. Large
sized-orders, usually made by pension funds or insurance companies, can have
a severe impact on stock price levels. AT aims to reduce that price impact by
splitting large orders into many small-sized orders, thereby offering traders
some price advantage. The
algorithms also dynamically control the schedule of sending orders to the
market. These algorithms read
real-time high-speed data feeds, detect trading signals, identify appropriate
price levels and then place trade orders once they identify a suitable
opportunity. They can also detect arbitrage opportunities and can place
trades based on trend following, news events, and even speculation. High-frequency
trading is an extension of algorithmic trading. It manages small-sized trade
orders to be sent to the market at
high speeds, often in milliseconds or microseconds—a
millisecond is a thousandth of a second and a microsecond is a thousandth of
a millisecond. These
orders are managed by high-speed
algorithms which replicate the role of a market maker. HFT algorithms
typically involve two-sided order
placements (buy-low and sell-high) in an attempt to benefit from bid-ask
spreads. HFT algorithms also try to “sense” any pending large-size orders by sending multiple
small-sized orders and analyzing the patterns and time taken in trade
execution. If they sense an opportunity, HFT algorithms then try to
capitalize on large pending orders by adjusting prices to fill them and make
profits. Also,
Ultra HFT is a further specialized stream of HFT. By paying an additional
exchange fee, trading firms get access to see pending orders a split-second before the rest of the market does. Profit Potential from HFT Exploiting
market conditions that can't be detected by the human eye, HFT algorithms
bank on finding profit potential in
the ultra-short time duration. One example is arbitrage between futures
and ETFs on the same underlying index. Automated Trading In
the U.S. markets, the SEC authorized automated
electronic exchanges in 1998. Roughly a year later, HFT began, with trade
execution time, at that time, being a few seconds. By 2010, this had been reduced to milliseconds—see
the speech by the Bank of England's Andrew Haldane's "Patience and finance"—and today, one-hundredth of a microsecond is enough time
for most HFT trade decisions and executions. Given ever-increasing computing
power, working at nanosecond and picosecond frequencies may be achievable via
HFT in the relatively near future. Bloomberg
reports that while in 2010, HFT "accounted for more than 60% of all U.S.
equity volume,” that proved to be a high-water mark.
By 2013, that percentage had fallen to roughly 50%. Bloomberg further noted
that where, in 2009, "high-frequency traders moved about 3.25 billion
shares a day. In 2012, it was 1.6 billion a day” and “average profits
have fallen from about a tenth of a penny per share to a twentieth of a
penny.” HFT Participants HFT
trading ideally needs to have the
lowest possible data latency (time-delays) and the maximum possible automation level. So participants prefer to
trade in markets with high levels of automation and integration capabilities
in their trading platforms. These include NASDAQ, NYSE, Direct Edge, and BATS. HFT
is dominated by proprietary trading firms and spans across multiple
securities, including equities,
derivatives, index funds, and ETFs, currencies and fixed income instruments.
A 2011 Deutsche Bank report found that of then-current HFT participants,
proprietary trading firms made up 48%, proprietary trading desks of
multi-service broker-dealers were 46% and hedge funds about 6%. Major names in the space include
proprietary trading firms like KWG Holdings (formed of the merger between
Getco and Knight Capital) and the trading desks of large institutional firms
like Citigroup (C), JP Morgan (JPM) and Goldman Sachs (GS). HFT Infrastructure Needs For
high-frequency trading, participants need the following infrastructure in place: ·
High-speed computers, which need regular
and costly hardware upgrades; ·
Co-location. That is, a typically
high-cost facility that places your trading computers as close as possible to
the exchange servers, to further reduce time delays; ·
Real-time data feeds, which are required
to avoid even a microsecond's delay that may impact profits; and ·
Computer algorithms, which are the heart
of AT and HFT. Benefits of HFT HFT
is beneficial to traders, but does it help the overall market? Some overall market benefits that HFT supporters
cite include: ·
Bid-ask spreads have reduced significantly
due to HFT trading, which makes markets more efficient. Empirical evidence
includes that after Canadian authorities in April 2012 imposed fees that
discouraged HFT, studies suggested that “the bid-ask
spread rose by 9%," possibly due to declining HFT trades.7 ·
HFT creates high liquidity and thus eases
the effects of market fragmentation. ·
HFT assists in the price discovery and price
formation process, as it is based on a large number of orders Challenges Of HFT Opponents
of HFT argue that algorithms can be programmed to send hundreds of fake orders and cancel them in the
next second. Such “spoofing” momentarily creates a false spike
in demand/supply leading to price anomalies, which can be exploited by HFT
traders to their advantage. In 2013, the SEC
introduced the Market Information
Data Analytics System (MIDAS), which screens multiple markets for data at
millisecond frequencies to try and catch fraudulent activities like “spoofing." Other obstacles to HFT's
growth are its high costs of entry, which
include: ·
Algorithms development ·
Setting up high-speed trade execution
platforms for timely trade execution ·
Building infrastructure that requires
frequent high-cost upgrades ·
Subscription charges towards data feed The
HFT marketplace also has gotten crowded, with participants trying to get an
edge over their competitors by constantly improving algorithms and adding to
infrastructure. Due to this "arms race," it's getting more
difficult for traders to capitalize on price anomalies, even if they have the
best computers and top-end networks. And
the prospect of costly glitches is also scaring away potential participants.
Some examples include the “Flash Crash" of May 6, 2010, where HFT-triggered sell orders
led to an impulsive drop of 600 points in the DJIA index.9 Then there's the case of Knight Capital,
the then-king of HFT on NYSE. It installed new software on Aug 1, 2012, and
accidentally bought and sold $7 billion worth of NYSE stocks at unfavorable
prices.10 Knight
was forced to settle its positions, costing it $440 million in one day and
eroding 40% of the firm’s value. Acquired by another HFT firm, Getco, to
form KCG Holdings, the merged entity still continues to struggle. So, some major bottlenecks
for HFT's future growth are its declining profit potential, high operational
costs, the prospect of stricter regulations and the fact that there is no
room for error, as losses can quickly run in the millions. The Bottom Line The
growth of computer speed and algorithm development has created seemingly
limitless possibilities in trading. But, AT and HFT are classic examples of
rapid developments that, for years, outpaced regulatory regimes and allowed
massive advantages to a relative handful of trading firms. While HFT may
offer reduced opportunities in the future for traders in established markets
like the U.S., some emerging markets could still be quite favorable for
high-stakes HFT ventures. Goldman
Sachs says computerized trading may make next 'flash crash' worse
· Goldman Sachs is worried the increasing
dominance of computerized trading may cause more volatility during market
downturns. · The firm says high-frequency trading
machines may "withdraw liquidity" at the worst possible moment in
the next financial crisis. Goldman Sachs is cautioning its clients that computerized
trading may exacerbate the volatility of the next big market sell-off. "One
theory that has been proposed for why market fragility could be higher today
is that because HFTs [high-frequency trading] supply liquidity
without taking into account fundamental information, they are forced to
withdraw liquidity during periods of market stress to avoid being adversely
selected," Charles Himmelberg, co-head of global markets
research at Goldman, said in a report Tuesday. "In our view, this at
least raises the risk that as machines have replaced people, and speed has
replaced capital, the inability of the market's liquidity providers to
process complex information may lead to surprisingly large drops in liquidity
when the next crisis hits." Himmelberg
noted the higher level of computerized trading has not been truly
"stress tested" during the bull market since the financial crisis.
He said the increasing incidents of volatility in various markets such as the VIX spike on Feb. 5, the 10-year Treasury bond on Oct.
15, 2014, and the British pound on Oct. 6, 2016, may be precursors of a
bigger one to come. The strategist said computerized
trading is generally not backed by large levels of capital, which could drive
the "collapse" of liquidity if the machines suffer any big losses
during a significant market downturn. "Future flash crashes may not end
well," he warned. "The quality of trading liquidity for even the
biggest, most heavily-traded markets should not be taken for granted." — With
reporting by CNBC's Michael Bloom. The stock market
halted trading Monday—here’s why younger investors shouldn’t panic Published Mon, Mar 9 202011:30 AM EDTUpdated Tue, Mar 10 20209:25 AM
EDT Megan Leonhardt@MEGAN_LEONHARDT The stock market opened on a rough note this week as fears that the
coronavirus will continue to have widespread economic impact drove down stock
prices. On Monday morning, the S&P 500 fell more than 7% at the open, triggering
circuit breakers that led the New York Stock Exchange to halt all market
trading for 15 minutes. The plunge, which occurred just after the market opened, triggered
what’s called a ‘circuit breaker’ that immediately halted trading. Basically,
this is a fail-safe that’s built into the system to allow for a short cool
down period. “The market circuit breakers are designed to slow trading down for a
few minutes, give investors the ability to understand what’s happening in the
market, consume the information and make decisions based on market
conditions,” New York Stock Exchange President Stacey Cunningham told CNBC’s
Bob Pisani. “This is operating as it’s supposed to.” The current system of circuit breakers has never been tripped. A
revamped system was put in place in February 2013 after the last set failed
to prevent the May 2010 flash crash. During regular trading hours, a circuit breaker can be triggered in a
few situations: 1. If the S&P 500
drops 7%, then trading will pause for 15 minutes. 2. If the S&P 500
declines 13% on or before 3:25 p.m. ET, then trading will be paused again for
15 minutes. If the drop occurs after 3:25 p.m., then there’s no halt. 3. If the S&P 500
falls 20%, then trading will be suspended for the rest of the day. Trading started back up at 9:49 a.m. ET and the S&P 500 continued
to slide. Meanwhile, the Dow Jones Industrial Average, which tracks 30
stocks, fell 2,000 points, or 7.3%, at one point during morning trading. The
Nasdaq, which features some of the market’s biggest technology names as well
as an assortment of other companies, fell 6.9% during the same period. “The bull market’s 11-year birthday is today, but investors are not in
a celebratory mood,” says Greg McBride, chartered financial analyst and chief
financial analyst at Bankrate.com. What it means for you Over 66% of millennials have investments of some type. About a third of
millennials invested in a taxable brokerage account in 2018, while another
third invested in a retirement account, according to a study of over 1,800
millennials (ages 23 to 38) sponsored by the CFA Institute and the FINRA
Investor Education Foundation. If you’re part of that group, the roller coaster markets do have an
impact on your investments, including your 401(k). But before you panic, keep
in mind that market downturns are fairly common. Market pullbacks with
declines of less than 20% have occurred over 100 times since 1946, according
to investment firm Guggenheim Funds. “Investing should never be about a moment in time; it should always be
about a process over time,” Liz Ann Sonders, chief investment strategist at
Charles Schwab, tells CNBC Make It. That’s a nice way of saying: Don’t time the market. Most millennials
(ages 24 to 39) have a long time horizon for their investments. Since there
are likely decades before you retire, even if a recession hits tomorrow or
next year, there’s plenty of time for your investments to bounce back.
Recessions and market downturns are part of a normal, healthy market cycle. 2:19 NYSE President Stacey Cunningham explains why stock trading was halted
for 15 minutes The best course of action right now is to keep investing and making
regular contributions to your 401(k). This routine influx of money into your
investment accounts is a strategy that experts call dollar-cost averaging.
It’s great for long-term investors because it takes emotion out of the
equation and keeps you from selling out during market lows and buying in at
market highs. A 401(k) is actually a good place to invest amid market volatility,
Sonders says. Typically, they’re structured in a way so that you’re buying on
a regimented basis and many have the option to invest in target date funds,
which have an automatic rebalancing process. “As the uncertainty persists, the market frenzy will continue, perhaps
for weeks, perhaps for months,” McBride says. “But long-term investors must
think in terms of years or decades.” Finally, just take a deep breath. Many millennials have strong “muscle
memory” from their own involvement, or their parents’ experiences, with the
market during the last financial crisis, Sonders says. Yet the reality is
that that market event was not the rule; it was more on the exceptional end
of the spectrum. “Markets fall sharply, but can also rebound quickly,” McBride says. “No
one knows when that comes and you don’t want to be sitting on the sidelines
when that happens.” The Work-From-Home Trader Who Shook
Global Markets (Bloomberg) (optional) |
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Chapter
2 What is Money Part I What is Money? · There is no single
"correct" measure of the money supply: instead, there are several
measures, classified along a spectrum or continuum between narrow and broad monetary aggregates. • Narrow measures include only the
most liquid assets, the ones most easily used to spend (currency, checkable
deposits). Broader measures add less liquid types of assets (certificates of
deposit, etc.)
· M0:
In some countries, such as the United Kingdom, M0 includes bank reserves, so
M0 is referred to as the monetary base, or narrow money. · MB:
is referred to as the monetary base or total currency. This is the base
from which other forms of money (like checking deposits, listed below) are
created and is traditionally the most liquid measure of the money supply. · M1: Bank
reserves are not included in M1. (M1 and Components @ Fed St. Louise website)
· M2:
Represents M1 and "close substitutes" for M1. M2 is a broader
classification of money than M1. M2 is a key economic indicator used to
forecast inflation. (M2 and
components @ Fed St. Louise website) · M3:
M2 plus large and long-term deposits. Since 2006, M3 is no longer published
by the US central bank. However, there are still estimates produced by
various private institutions. (M3 and
components at Fed St. Louise website) ·
Let’s watch this money supply
video: Draw Me The Economy: Money Supply
(video)
For discussion: ·
What could happen if we
increase money supply? ·
What about reduce money supply? ·
What are the possible ways to reduce
money supply? ·
Among M0, M1, M2, M3, which
one is the correct measure of money? ·
Why M2 is >> M0? ·
Why does M2 increase much
faster than M1? Does it has any impact on you? For more information, please visit http://www.data360.org/report_slides.aspx?Print_Group_Id=168 https://fred.stlouisfed.org/categories/24
For discussion: ·
Among M0, M1, and
M2, which one is used as a measure for money supply in US? ·
Why is M2 multiple
times of Mo? ·
What are the
expected consequences resulted from a big increase in money supply? ·
Do you think that
US$ will devalue in the near future? ·
What do you suggest
in terms of investment? Bitcoin? Commodity? Stock? Bond? Why? Summary:
Money Supply M2 in the United States
increased to 14872.10 USD Billion in July from 14755.10 USD Billion in June
of 2019. oney Supply M2 in the United States averaged 4121.70 USD Billion
from 1959 until 2019, reaching an all time high of 14872.10 USD Billion in
July of 2019 and a record low of 286.60 USD Billion in January of 1959.
From https://tradingeconomics.com/united-states/money-supply-m2
M2 of other countries
Money supplies have increased rapidly in every country. Why? Does it
make any sense? What are be the possible consequences, in your opinion? From https://www.federalreserve.gov/releases/h6/current/default.htm
Table
1
Money Stock Measures.
Billions of dollars.
Table 2
Money Stock Measures.
Billions of dollars.
Table 3
Seasonally Adjusted
Components of M1. Billions of dollars.
Table 4
Seasonally Adjusted
Components of Non-M1 M2. Billions of dollars.
|
Beyond
Bitcoin bubble – New York Times (FYI only) https://www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html The sequence of
words is meaningless: a random array strung together by an algorithm let
loose in an English dictionary. What makes them valuable is that they’ve been
generated exclusively for me, by a software tool called MetaMask. In the lingo of cryptography, they’re known as my seed
phrase. They might read like an incoherent stream of consciousness, but these
words can be transformed into a key that unlocks a digital bank account, or
even an online identity. It just takes a few more steps. On the screen,
I’m instructed to keep my seed phrase secure: Write it down, or keep it in a
secure place on your computer. I scribble the 12 words onto a notepad, click
a button and my seed phrase is transformed into a string of 64 seemingly
patternless characters: 1b0be2162cedb2744d016943bb14e71de6af95a63af3790d6b41b1e719dc5c66 This is what’s
called a “private key” in the
world of cryptography: a way of proving identity, in the same, limited way
that real-world keys attest to your identity when you unlock your front door.
My seed phrase will generate that exact sequence of characters every time,
but there’s no known way to reverse-engineer the original phrase from the
key, which is why it is so important to keep the seed phrase in a safe
location. That private key number is then run through two
additional transformations, creating a new string: 0x6c2ecd6388c550e8d99ada34a1cd55bedd052ad9 That string is my address on the Ethereum
blockchain. Ethereum
belongs to the same family as the cryptocurrency Bitcoin, whose value has
increased more than 1,000 percent in just the past year. Ethereum has its own
currencies, most notably Ether, but the platform has a wider scope than just
money. You can think of my Ethereum address as having elements of a bank
account, an email address and a Social Security number. For now, it exists
only on my computer as an inert string of nonsense, but the second I try to
perform any kind of transaction — say, contributing to a crowdfunding
campaign or voting in an online referendum — that address is broadcast out to
an improvised worldwide network of computers that tries to verify the
transaction. The results of that verification are then broadcast to the wider
network again, where more machines enter into a kind of competition to
perform complex mathematical calculations, the winner of which gets to record
that transaction in the single, canonical record of every transaction ever
made in the history of Ethereum. Because
those transactions are registered in a sequence of “blocks” of data, that
record is called the blockchain. The whole
exchange takes no more than a few minutes to complete. From my perspective,
the experience barely differs from the usual routines of online life. But on
a technical level, something miraculous is happening — something that would
have been unimaginable just a decade ago.
I’ve managed to complete a secure transaction without any of the traditional
institutions that we rely on to establish trust. No intermediary brokered
the deal; no social-media network captured the data from my transaction to
better target its advertising; no credit bureau tracked the activity to build
a portrait of my financial trustworthiness. And the platform that makes all this possible?
No one owns it. There are no venture investors backing Ethereum Inc.,
because there is no Ethereum Inc. As an organizational form, Ethereum is far
closer to a democracy than a private corporation. No imperial chief executive
calls the shots. You earn the privilege of helping to steer Ethereum’s ship
of state by joining the community and doing the work. Like Bitcoin and most
other blockchain platforms, Ethereum is more a swarm than a formal entity.
Its borders are porous; its hierarchy is deliberately flattened. Oh, one other
thing: Some members of that swarm have already accumulated a paper net worth
in the billions from their labors, as the value of one “coin” of Ether rose
from $8 on Jan. 1, 2017, to $843 exactly one year later. You may be inclined
to dismiss these transformations. After all, Bitcoin and Ether’s runaway
valuation looks like a case study in irrational exuberance. And why should
you care about an arcane technical breakthrough that right now doesn’t feel
all that different from signing in to a website to make a credit card
payment? ‘The Bitcoin
bubble may ultimately turn out to be a distraction from the true significance
of the blockchain.’ But that
dismissal would be shortsighted. If there’s one thing we’ve learned from the
recent history of the internet, it’s that seemingly esoteric decisions about
software architecture can unleash profound global forces once the technology
moves into wider circulation. If the email standards adopted in the 1970s had
included public-private key cryptography as a default setting, we might have
avoided the cataclysmic email hacks that have afflicted everyone from Sony to
John Podesta, and millions of ordinary consumers might be spared routinized
identity theft. If Tim Berners-Lee, the inventor of the World Wide Web, had
included a protocol for mapping our social identity in his original specs, we
might not have Facebook. The true
believers behind blockchain platforms like Ethereum argue that a network of
distributed trust is one of those advances in software architecture that will
prove, in the long run, to have historic significance. That promise has
helped fuel the huge jump in cryptocurrency valuations. But in a way, the
Bitcoin bubble may ultimately turn out to be a distraction from the true significance
of the blockchain. The real promise of
these new technologies, many of their evangelists believe, lies not in
displacing our currencies but in replacing much of what we now think of as
the internet, while at the same time returning the online world to a more
decentralized and egalitarian system. If you believe the evangelists, the
blockchain is the future. But it is also a way of getting back to the
internet’s roots. Once the
inspiration for utopian dreams of infinite libraries and global connectivity,
the internet has seemingly become, over the past year, a universal scapegoat:
the cause of almost every social ill that confronts us. Russian trolls
destroy the democratic system with fake news on Facebook; hate speech
flourishes on Twitter and Reddit; the vast fortunes of the geek elite worsen
income equality. For many of us who participated in the early days of the
web, the last few years have felt almost postlapsarian. The web had promised
a new kind of egalitarian media, populated by small magazines, bloggers and
self-organizing encyclopedias; the information titans that dominated mass
culture in the 20th century would give way to a more decentralized system,
defined by collaborative networks, not hierarchies and broadcast channels.
The wider culture would come to mirror the peer-to-peer architecture of the
internet itself. The web in those days was hardly a utopia — there were
financial bubbles and spammers and a thousand other problems — but beneath
those flaws, we assumed, there was an underlying story of progress. Last year
marked the point at which that narrative finally collapsed. The existence of
internet skeptics is nothing new, of course; the difference now is that the
critical voices increasingly belong to former enthusiasts. “We have to fix
the internet,” Walter Isaacson, Steve Jobs’s biographer, wrote in an essay
published a few weeks after Donald Trump was elected president. “After 40
years, it has begun to corrode, both itself and us.” The former Google
strategist James Williams told The Guardian: “The dynamics of the attention
economy are structurally set up to undermine the human will.” In a blog post,
Brad Burnham, a managing partner at Union Square Ventures, a top New York
venture-capital firm, bemoaned the collateral damage from the quasi
monopolies of the digital age: “Publishers find themselves becoming commodity
content suppliers in a sea of undifferentiated content in the Facebook news
feed. Websites see their fortunes upended by small changes in Google’s search
algorithms. And manufacturers watch helplessly as sales dwindle when Amazon
decides to source products directly in China and redirect demand to their own
products.” (Full disclosure: Burnham’s firm invested in a company I started
in 2006; we have had no financial relationship since it sold in 2011.) Even
Berners-Lee, the inventor of the web itself, wrote a blog post voicing his
concerns that the advertising-based model of social media and search engines
creates a climate where “misinformation, or ‘fake news,’ which is surprising,
shocking or designed to appeal to our biases, can spread like wildfire.” For most
critics, the solution to these immense structural issues has been to propose
either a new mindfulness about the dangers of these tools — turning off our
smartphones, keeping kids off social media — or the strong arm of regulation
and antitrust: making the tech giants subject to the same scrutiny as other
industries that are vital to the public interest, like the railroads or
telephone networks of an earlier age. Both those ideas are commendable: We
probably should develop a new set of habits governing how we interact with
social media, and it seems entirely sensible that companies as powerful as
Google and Facebook should face the same regulatory scrutiny as, say,
television networks. But those interventions are unlikely to fix the core
problems that the online world confronts. After all, it was not just the
antitrust division of the Department of Justice that challenged Microsoft’s
monopoly power in the 1990s; it was also the emergence of new software and
hardware — the web, open-source software and Apple products — that helped
undermine Microsoft’s dominant position. The blockchain evangelists behind platforms like
Ethereum believe that a comparable array of advances in software,
cryptography and distributed systems has the ability to tackle today’s
digital problems: the corrosive incentives of online advertising; the quasi
monopolies of Facebook, Google and Amazon; Russian misinformation campaigns.
If they succeed, their creations may challenge the hegemony of the tech
giants far more effectively than any antitrust regulation. They even claim to
offer an alternative to the winner-take-all model of capitalism than has
driven wealth inequality to heights not seen since the age of the robber
barons. That remedy is
not yet visible in any product that would be intelligible to an ordinary tech
consumer. The only blockchain project that has crossed over into mainstream
recognition so far is Bitcoin, which is in the middle of a speculative bubble
that makes the 1990s internet I.P.O. frenzy look like a neighborhood garage
sale. And herein lies the cognitive dissonance that confronts anyone trying
to make sense of the blockchain: the potential power of this would-be
revolution is being actively undercut by the crowd it is attracting, a
veritable goon squad of charlatans, false prophets and mercenaries. Not for
the first time, technologists pursuing a vision of an open and decentralized
network have found themselves surrounded by a wave of opportunists looking to
make an overnight fortune. The question is whether, after the bubble has
burst, the very real promise of the blockchain can endure. To some students of
modern technological history, the internet’s fall from grace follows an
inevitable historical script. As Tim Wu argued in his 2010 book, “The Master
Switch,” all the major information technologies of the 20th century adhered
to a similar developmental pattern, starting out as the playthings of
hobbyists and researchers motivated by curiosity and community, and ending up
in the hands of multinational corporations fixated on maximizing shareholder
value. Wu calls this pattern the Cycle, and on the surface at least, the
internet has followed the Cycle with convincing fidelity. The internet began
as a hodgepodge of government-funded academic research projects and
side-hustle hobbies. But 20 years after the web first crested into the
popular imagination, it has produced in Google, Facebook and Amazon — and
indirectly, Apple — what may well be the most powerful and valuable
corporations in the history of capitalism. Blockchain
advocates don’t accept the inevitability of the Cycle. The roots of the
internet were in fact more radically open and decentralized than previous
information technologies, they argue, and had we managed to stay true to
those roots, it could have remained that way. The online world would not be dominated by a handful of
information-age titans; our news platforms would be less vulnerable to
manipulation and fraud; identity theft would be far less common; advertising
dollars would be distributed across a wider range of media properties. To understand
why, it helps to think of the internet as two fundamentally different kinds
of systems stacked on top of each other, like layers in an archaeological
dig. One layer is composed of the software protocols that were developed in
the 1970s and 1980s and hit critical mass, at least in terms of audience, in
the 1990s. (A protocol is the software version of a lingua franca, a way that
multiple computers agree to communicate with one another. There are protocols
that govern the flow of the internet’s raw data, and protocols for sending
email messages, and protocols that define the addresses of web pages.) And
then above them, a second layer of web-based services — Facebook, Google,
Amazon, Twitter — that largely came to power in the following decade. The first
layer — call it InternetOne — was founded on open protocols, which in turn
were defined and maintained by academic researchers and
international-standards bodies, owned by no one. In fact, that original
openness continues to be all around us, in ways we probably don’t appreciate
enough. Email is still based on the open protocols POP, SMTP and IMAP;
websites are still served up using the open protocol HTTP; bits are still
circulated via the original open protocols of the internet, TCP/IP. You don’t
need to understand anything about how these software conventions work on a
technical level to enjoy their benefits. The key characteristic they all
share is that anyone can use them, free of charge. You don’t need to pay a
licensing fee to some corporation that owns HTTP if you want to put up a web
page; you don’t have to sell a part of your identity to advertisers if you
want to send an email using SMTP. Along with Wikipedia, the open protocols of
the internet constitute the most impressive example of commons-based
production in human history. To see how
enormous but also invisible the benefits of such protocols have been, imagine
that one of those key standards had not been developed: for instance, the
open standard we use for defining our geographic location, GPS. Originally
developed by the United States military, the Global Positioning System was
first made available for civilian use during the Reagan administration. For
about a decade, it was largely used by the aviation industry, until
individual consumers began to use it in car navigation systems. And now we
have smartphones that can pick up a signal from GPS satellites orbiting above
us, and we use that extraordinary power to do everything from locating nearby
restaurants to playing Pokémon Go to coordinating disaster-relief efforts. But what if
the military had kept GPS out of the public domain? Presumably, sometime in the
1990s, a market signal would have gone out to the innovators of Silicon
Valley and other tech hubs, suggesting that consumers were interested in
establishing their exact geographic coordinates so that those locations could
be projected onto digital maps. There would have been a few years of furious
competition among rival companies, who would toss their own proprietary
satellites into orbit and advance their own unique protocols, but eventually
the market would have settled on one dominant model, given all the
efficiencies that result from a single, common way of verifying location.
Call that imaginary firm GeoBook. Initially, the embrace of GeoBook would
have been a leap forward for consumers and other companies trying to build
location awareness into their hardware and software. But slowly, a darker
narrative would have emerged: a single private corporation, tracking the
movements of billions of people around the planet, building an advertising
behemoth based on our shifting locations. Any start-up trying to build a
geo-aware application would have been vulnerable to the whims of mighty
GeoBook. Appropriately angry polemics would have been written denouncing the
public menace of this Big Brother in the sky. But none of
that happened, for a simple reason. Geolocation, like the location of web
pages and email addresses and domain names, is a problem we solved with an
open protocol. And because it’s a problem we don’t have, we rarely think
about how beautifully GPS does work and how many different applications have
been built on its foundation. The open,
decentralized web turns out to be alive and well on the InternetOne layer.
But since we settled on the World Wide Web in the mid-’90s, we’ve adopted
very few new open-standard protocols. The biggest problems that technologists
tackled after 1995 — many of which revolved around identity, community and
payment mechanisms — were left to the private sector to solve. This is what
led, in the early 2000s, to a powerful new layer of internet services, which
we might call InternetTwo. For all their
brilliance, the inventors of the open protocols that shaped the internet
failed to include some key elements that would later prove critical to the
future of online culture. Perhaps most important, they did not create a secure
open standard that established human identity on the network. Units of
information could be defined — pages, links, messages — but people did
not have their own protocol: no way to define and share your real name, your
location, your interests or (perhaps most crucial) your relationships to
other people online. This turns out
to have been a major oversight, because identity is the sort of problem that
benefits from one universally recognized solution. It’s what Vitalik Buterin,
a founder of Ethereum, describes as “base-layer” infrastructure: things like
language, roads and postal services, platforms where commerce and competition
are actually assisted by having an underlying layer in the public domain.
Offline, we don’t have an open market for physical passports or Social
Security numbers; we have a few reputable authorities — most of them backed
by the power of the state — that we use to confirm to others that we are who
we say we are. But online, the private sector swooped in to fill that vacuum,
and because identity had that characteristic of being a universal problem,
the market was heavily incentivized to settle on one common standard for
defining yourself and the people you know. The
self-reinforcing feedback loops that economists call “increasing returns” or
“network effects” kicked in, and after a period of experimentation in which
we dabbled in social-media start-ups like Myspace and Friendster, the market
settled on what is essentially a proprietary standard for establishing who
you are and whom you know. That standard is Facebook. With more than two
billion users, Facebook is far larger than the entire internet at the peak of
the dot-com bubble in the late 1990s. And that user growth has made it the
world’s sixth-most-valuable corporation, just 14 years after it was founded.
Facebook is the ultimate embodiment of the chasm that divides InternetOne and
InternetTwo economies. No private company owned the protocols that defined
email or GPS or the open web. But one single corporation owns the data that
define social identity for two billion people today — and one single person,
Mark Zuckerberg, holds the majority of the voting power in that corporation. If you see the
rise of the centralized web as an inevitable turn of the Cycle, and the
open-protocol idealism of the early web as a kind of adolescent false
consciousness, then there’s less reason to fret about all the ways we’ve
abandoned the vision of InternetOne. Either we’re living in a fallen state
today and there’s no way to get back to Eden, or Eden itself was a kind of
fantasy that was always going to be corrupted by concentrated power. In
either case, there’s no point in trying to restore the architecture of
InternetOne; our only hope is to use the power of the state to rein in these
corporate giants, through regulation and antitrust action. It’s a variation
of the old Audre Lorde maxim: “The master’s tools will never dismantle the
master’s house.” You can’t fix the problems technology has created for us by
throwing more technological solutions at it. You need forces outside the
domain of software and servers to break up cartels with this much power. But the thing
about the master’s house, in this analogy, is that it’s a duplex. The upper
floor has indeed been built with tools that cannot be used to dismantle it.
But the open protocols beneath them still have the potential to build
something better. One of the most persuasive advocates of an open-protocol revival is Juan
Benet, a Mexican-born programmer now living on a suburban side street in Palo
Alto, Calif., in a three-bedroom rental that he shares with his girlfriend
and another programmer, plus a rotating cast of guests, some of whom belong
to Benet’s organization, Protocol Labs. On a warm day in September, Benet
greeted me at his door wearing a black Protocol Labs hoodie. The interior of
the space brought to mind the incubator/frat house of HBO’s “Silicon Valley,”
its living room commandeered by an array of black computer monitors. In the
entrance hallway, the words “Welcome to Rivendell” were scrawled out on a
whiteboard, a nod to the Elven city from “Lord of the Rings.” “We call this
house Rivendell,” Benet said sheepishly. “It’s not a very good Rivendell. It
doesn’t have enough books, or waterfalls, or elves.” Benet, who is
29, considers himself a child of the first peer-to-peer revolution that
briefly flourished in the late 1990s and early 2000s, driven in large part by
networks like BitTorrent that distributed media files, often illegally. That
initial flowering was in many ways a logical outgrowth of the internet’s
decentralized, open-protocol roots. The web had shown that you could publish
documents reliably in a commons-based network. Services like BitTorrent or
Skype took that logic to the next level, allowing ordinary users to add new
functionality to the internet: creating a distributed library of (largely
pirated) media, as with BitTorrent, or helping people make phone calls over
the internet, as with Skype. ‘We’re not
trying to replace the U.S. government. It’s not meant to be a real currency;
it’s meant to be a pseudo-currency inside this world.’ Sitting in the
living room/office at Rivendell, Benet told me that he thinks of the early
2000s, with the ascent of Skype and BitTorrent, as “the ‘summer’ of
peer-to-peer” — its salad days. “But then peer-to-peer hit a wall, because
people started to prefer centralized architectures,” he said. “And partly
because the peer-to-peer business models were piracy-driven.” A graduate of
Stanford’s computer-science program, Benet talks in a manner reminiscent of
Elon Musk: As he speaks, his eyes dart across an empty space above your head,
almost as though he’s reading an invisible teleprompter to find the words. He
is passionate about the technology Protocol Labs is developing, but also keen
to put it in a wider context. For Benet, the shift from distributed systems
to more centralized approaches set in motion changes that few could have
predicted. “The rules of the game, the rules that govern all of this
technology, matter a lot,” he said. “The structure of what we build now will
paint a very different picture of the way things will be five or 10 years in
the future.” He continued: “It was clear to me then that peer-to-peer was
this extraordinary thing. What was not clear to me then was how at risk it is.
It was not clear to me that you had to take up the baton, that it’s now your
turn to protect it.” Protocol Labs
is Benet’s attempt to take up that baton, and its first project is a radical
overhaul of the internet’s file system, including the basic scheme we use to
address the location of pages on the web. Benet calls his system IPFS, short
for InterPlanetary File System. The current protocol — HTTP — pulls down web
pages from a single location at a time and has no built-in mechanism for
archiving the online pages. IPFS allows users to download a page
simultaneously from multiple locations and includes what programmers call
“historic versioning,” so that past iterations do not vanish from the
historical record. To support the protocol, Benet is also creating a system
called Filecoin that will allow users to effectively rent out unused
hard-drive space. (Think of it as a sort of Airbnb for data.) “Right now
there are tons of hard drives around the planet that are doing nothing, or
close to nothing, to the point where their owners are just losing money,”
Benet said. “So you can bring online a massive amount of supply, which will
bring down the costs of storage.” But as its name suggests, Protocol Labs has
an ambition that extends beyond these projects; Benet’s larger mission is to
support many new open-source protocols in the years to come. Why did the
internet follow the path from open to closed? One part of the explanation
lies in sins of omission: By the time a new generation of coders began to
tackle the problems that InternetOne left unsolved, there were near-limitless
sources of capital to invest in those efforts, so long as the coders kept
their systems closed. The secret to the success of the open protocols of
InternetOne is that they were developed in an age when most people didn’t
care about online networks, so they were able to stealthily reach critical
mass without having to contend with wealthy conglomerates and venture
capitalists. By the mid-2000s, though, a promising new start-up like Facebook
could attract millions of dollars in financing even before it became a
household brand. And that private-sector money ensured that the company’s key
software would remain closed, in order to capture as much value as possible
for shareholders. And yet — as
the venture capitalist Chris Dixon points out — there was another factor,
too, one that was more technical than financial in nature. “Let’s say you’re
trying to build an open Twitter,” Dixon explained while sitting in a
conference room at the New York offices of Andreessen Horowitz, where he is a
general partner. “I’m @cdixon at Twitter. Where do you store that? You need a
database.” A closed architecture like Facebook’s or Twitter’s puts all the
information about its users — their handles, their likes and photos, the map
of connections they have to other individuals on the network — into a private
database that is maintained by the company. Whenever you look at your
Facebook newsfeed, you are granted access to some infinitesimally small
section of that database, seeing only the information that is relevant to
you. Running
Facebook’s database is an unimaginably complex operation, relying on hundreds
of thousands of servers scattered around the world, overseen by some of the
most brilliant engineers on the planet. From Facebook’s point of view,
they’re providing a valuable service to humanity: creating a common social
graph for almost everyone on earth. The fact that they have to sell ads to
pay the bills for that service — and the fact that the scale of their network
gives them staggering power over the minds of two billion people around the
world — is an unfortunate, but inevitable, price to pay for a shared social
graph. And that trade-off did in fact make sense in the mid-2000s; creating a
single database capable of tracking the interactions of hundreds of millions
of people — much less two billion — was the kind of problem that could be
tackled only by a single organization. But as Benet and his fellow blockchain
evangelists are eager to prove, that might not be true anymore. So how can you
get meaningful adoption of base-layer protocols in an age when the big tech
companies have already attracted billions of users and collectively sit on
hundreds of billions of dollars in cash? If you happen to believe that the internet,
in its current incarnation, is causing significant and growing harm to
society, then this seemingly esoteric problem — the difficulty of getting
people to adopt new open-source technology standards — turns out to have
momentous consequences. If we can’t figure out a way to introduce new, rival
base-layer infrastructure, then we’re stuck with the internet we have today.
The best we can hope for is government interventions to scale back the power
of Facebook or Google, or some kind of consumer revolt that encourages that
marketplace to shift to less hegemonic online services, the digital
equivalent of forswearing big agriculture for local farmers’ markets. Neither
approach would upend the underlying dynamics of Internet Two. The first hint of a
meaningful challenge to the closed-protocol era arrived in 2008, not long
after Zuckerberg opened the first international headquarters for his growing
company. A mysterious programmer (or group of programmers) going by the name
Satoshi Nakamoto circulated a paper on a cryptography mailing list. The paper
was called “Bitcoin: A Peer-to-Peer Electronic Cash System,” and in it,
Nakamoto outlined an ingenious system for a digital currency that did not
require a centralized trusted authority to verify transactions. At the time,
Facebook and Bitcoin seemed to belong to entirely different spheres — one was
a booming venture-backed social-media start-up that let you share birthday
greetings and connect with old friends, while the other was a byzantine
scheme for cryptographic currency from an obscure email list. But 10 years
later, the ideas that Nakamoto unleashed with that paper now pose the most
significant challenge to the hegemony of InternetTwo giants like Facebook. The paradox about Bitcoin is that it may well
turn out to be a genuinely revolutionary breakthrough and at the same time a
colossal failure as a currency. As I write, Bitcoin has
increased in value by nearly 100,000 percent over the past five years, making
a fortune for its early investors but also branding it as a spectacularly
unstable payment mechanism. The process for creating new Bitcoins has also
turned out to be a staggering energy drain. History is
replete with stories of new technologies whose initial applications end up
having little to do with their eventual use. All the focus on Bitcoin as a
payment system may similarly prove to be a distraction, a technological red
herring. Nakamoto pitched Bitcoin as a
“peer-to-peer electronic-cash system” in the initial manifesto, but at its
heart, the innovation he (or she or they) was proposing had a more general
structure, with two key features. First, Bitcoin offered a kind of proof that you
could create a secure database — the blockchain — scattered across hundreds or
thousands of computers, with no single authority controlling and verifying
the authenticity of the data. Second, Nakamoto designed Bitcoin so that the
work of maintaining that distributed ledger was itself rewarded with small,
increasingly scarce Bitcoin payments. If you dedicated half your
computer’s processing cycles to helping the Bitcoin network get its math
right — and thus fend off the hackers and scam artists — you received a small
sliver of the currency. Nakamoto designed the system so that Bitcoins would
grow increasingly difficult to earn over time, ensuring a certain amount of
scarcity in the system. If you helped Bitcoin keep that database secure in
the early days, you would earn more Bitcoin than later arrivals. This process
has come to be called “mining.” For our
purposes, forget everything else about the Bitcoin frenzy, and just keep
these two things in mind: What
Nakamoto ushered into the world was a way of agreeing on the contents of a
database without anyone being “in charge” of the database, and a way of
compensating people for helping make that database more valuable, without
those people being on an official payroll or owning shares in a corporate
entity. Together, those two ideas solved the distributed-database problem and
the funding problem. Suddenly there was a way of supporting open protocols
that wasn’t available during the infancy of Facebook and Twitter. These two
features have now been replicated in dozens of new systems inspired by
Bitcoin. One of those systems is Ethereum, proposed in a white paper by
Vitalik Buterin when he was just 19. Ethereum
does have its currencies, but at its heart Ethereum was designed less to
facilitate electronic payments than to allow people to run applications on
top of the Ethereum blockchain. There are currently hundreds of Ethereum
apps in development, ranging from prediction markets to Facebook clones to
crowdfunding services. Almost all of them are in pre-alpha stage, not ready
for consumer adoption. Despite the embryonic state of the applications, the
Ether currency has seen its own miniature version of the Bitcoin bubble, most
likely making Buterin an immense fortune. These
currencies can be used in clever ways. Juan
Benet’s Filecoin system will rely on Ethereum technology and reward users and
developers who adopt its IPFS protocol or help maintain the shared database
it requires. Protocol Labs is
creating its own cryptocurrency, also called Filecoin, and has plans to sell
some of those coins on the open market in the coming months. (In the summer
of 2017, the company raised $135 million in the first 60 minutes of what
Benet calls a “presale” of the tokens to accredited investors.) Many cryptocurrencies are first made
available to the public through a process known as an initial coin offering,
or I.C.O. The I.C.O.
abbreviation is a deliberate echo of the initial public offering that so
defined the first internet bubble in the 1990s. But there is a crucial
difference between the two. Speculators
can buy in during an I.C.O., but they are not buying an ownership stake in a
private company and its proprietary software, the way they might in a
traditional I.P.O. Afterward, the coins will continue to be created in
exchange for labor — in the case of Filecoin, by anyone who helps maintain
the Filecoin network. Developers who help refine the software can earn the
coins, as can ordinary users who lend out spare hard-drive space to expand
the network’s storage capacity. The Filecoin is a way of signaling that
someone, somewhere, has added value to the network. . You need new code. |
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Part II What is
Fractional Banking System? Money Creation in a
Fractional Reserve Banking System
In
a fractional reserve banking system, banks create money when they make loans. Bank
reserves have a multiplier effect on the money supply. Example: You deposited $1,000 in a local bank
Summary:
|
(continuing from above) Advocates like Chris Dixon have started
referring to the compensation side of the equation in terms of “tokens,” not
coins, to emphasize that the technology here isn’t necessarily aiming to
disrupt existing currency systems. “I like the metaphor of a
token because it makes it very clear that it’s like an arcade,” he says. “You
go to the arcade, and in the arcade you can use these tokens. But we’re not
trying to replace the U.S. government. It’s not meant to be a real currency;
it’s meant to be a pseudo-currency inside this world.” Dan Finlay, a creator
of MetaMask, echoes Dixon’s argument. “To me, what’s interesting about this
is that we get to program new value systems,” he says. “They don’t have to
resemble money.” Pseudo or not,
the idea of an I.C.O. has already inspired a host of shady offerings, some of
them endorsed by celebrities who would seem to be unlikely blockchain
enthusiasts, like DJ Khaled, Paris Hilton and Floyd Mayweather. In a blog
post published in October 2017, Fred Wilson, a founder of Union Square
Ventures and an early advocate of the blockchain revolution, thundered
against the spread of I.C.O.s. “I hate it,” Wilson wrote, adding that most
I.C.O.s “are scams. And the celebrities and others who promote them on their
social-media channels in an effort to enrich themselves are behaving badly
and possibly violating securities laws.” Arguably the most striking thing
about the surge of interest in I.C.O.s — and in existing currencies like
Bitcoin or Ether — is how much financial speculation has already gravitated
to platforms that have effectively zero adoption among ordinary consumers. At
least during the internet bubble of late 1990s, ordinary people were buying
books on Amazon or reading newspapers online; there was clear evidence that
the web was going to become a mainstream platform. Today, the hype cycles are
so accelerated that billions of dollars are chasing a technology that almost
no one outside the cryptocommunity understands, much less uses. Let’s say, for the sake
of argument, that the hype is warranted, and blockchain platforms like
Ethereum become a fundamental part of our digital infrastructure. How would a
distributed ledger and a token economy somehow challenge one of the tech
giants? One of Fred Wilson’s partners at Union Square Ventures, Brad Burnham,
suggests a scenario revolving around another tech giant that has run afoul of
regulators and public opinion in the last year: Uber. “Uber is basically just
a coordination platform between drivers and passengers,” Burnham says. “Yes,
it was really innovative, and there were a bunch of things in the beginning
about reducing the anxiety of whether the driver was coming or not, and the
map — and a whole bunch of things that you should give them a lot of credit for.”
But when a new service like Uber starts to take off, there’s a strong
incentive for the marketplace to consolidate around a single leader. The fact
that more passengers are starting to use the Uber app attracts more drivers
to the service, which in turn attracts more passengers. People have their
credit cards stored with Uber; they have the app installed already; there are
far more Uber drivers on the road. And so the switching costs of trying out
some other rival service eventually become prohibitive, even if the chief
executive seems to be a jerk or if consumers would, in the abstract, prefer a
competitive marketplace with a dozen Ubers. “At some point, the innovation
around the coordination becomes less and less innovative,” Burnham says. The blockchain
world proposes something different. Imagine some group like Protocol Labs
decides there’s a case to be made for adding another “basic layer” to the
stack. Just as GPS gave us a way of discovering and sharing our location,
this new protocol would define a simple request: I am here and would like to
go there. A distributed ledger might record all its users’ past trips, credit
cards, favorite locations — all the metadata that services like Uber or
Amazon use to encourage lock-in. Call it, for the sake of argument, the
Transit protocol. The standards for sending a Transit request out onto the
internet would be entirely open; anyone who wanted to build an app to respond
to that request would be free to do so. Cities could build Transit apps that
allowed taxi drivers to field requests. But so could bike-share collectives,
or rickshaw drivers. Developers could create shared marketplace apps where
all the potential vehicles using Transit could vie for your business. When
you walked out on the sidewalk and tried to get a ride, you wouldn’t have to
place your allegiance with a single provider before hailing. You would simply
announce that you were standing at 67th and Madison and needed to get to
Union Square. And then you’d get a flurry of competing offers. You could even
theoretically get an offer from the M.T.A., which could build a service to
remind Transit users that it might be much cheaper and faster just to jump on
the 6 train. How would
Transit reach critical mass when Uber and Lyft already dominate the ride-sharing
market? This is where the tokens come in. Early adopters of Transit would be
rewarded with Transit tokens, which could themselves be used to purchase
Transit services or be traded on exchanges for traditional currency. As in
the Bitcoin model, tokens would be doled out less generously as Transit grew
more popular. In the early days, a developer who built an iPhone app that
uses Transit might see a windfall of tokens; Uber drivers who started using
Transit as a second option for finding passengers could collect tokens as a
reward for embracing the system; adventurous consumers would be rewarded with
tokens for using Transit in its early days, when there are fewer drivers
available compared with the existing proprietary networks like Uber or Lyft. As Transit
began to take off, it would attract speculators, who would put a monetary
price on the token and drive even more interest in the protocol by inflating
its value, which in turn would attract more developers, drivers and
customers. If the whole system ends up working as its advocates believe, the
result is a more competitive but at the same time more equitable marketplace.
Instead of all the economic value being captured by the shareholders of one
or two large corporations that dominate the market, the economic value is
distributed across a much wider group: the early developers of Transit, the
app creators who make the protocol work in a consumer-friendly form, the
early-adopter drivers and passengers, the first wave of speculators. Token
economies introduce a strange new set of elements that do not fit the
traditional models: instead of creating value by owning something, as in the
shareholder equity model, people create value by improving the underlying
protocol, either by helping to maintain the ledger (as in Bitcoin mining), or
by writing apps atop it, or simply by using the service. The lines between
founders, investors and customers are far blurrier than in traditional
corporate models; all the incentives are explicitly designed to steer away
from winner-take-all outcomes. And yet at the same time, the whole system
depends on an initial speculative phase in which outsiders are betting on the
token to rise in value. “You think
about the ’90s internet bubble and all the great infrastructure we got out of
that,” Dixon says. “You’re basically taking that effect and shrinking it down
to the size of an application.” ‘Bitcoin is now a nine-year-old
multibillion-dollar bug bounty, and no one’s hacked it. It feels like pretty
good proof.’ Even
decentralized cryptomovements have
their key nodes. For Ethereum, one of those nodes is the Brooklyn
headquarters of an organization called ConsenSys, founded by Joseph Lubin, an
early Ethereum pioneer. In November, Amanda Gutterman, the 26-year-old chief
marketing officer for ConsenSys, gave me a tour of the space. In our first
few minutes together, she offered the obligatory cup of coffee, only to
discover that the drip-coffee machine in the kitchen was bone dry. “How can
we fix the internet if we can’t even make coffee?” she said with a laugh. |
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Part III: Crypto currency ppt
(Thanks, Chris) https://www.coinbase.com/price Top
50 crypocurrency
What is Bitcoin? (video)
What is bitcoin? By Khan Academy (video) (optional) Two
Biggest Threats To The Ongoing Bitcoin And Ethereum Rallies https://www.forbes.com/sites/youngjoseph/2020/09/01/bitcoin-dollar-ethereum/#358120e95939 Joseph Young Contributor The price of Bitcoin rose to as high as
$12,086 on Coinbase, as Ethereum (ETH) buoyed overall market sentiment. While
the cryptocurrency market’s momentum is evidently strong, there are two
potential threats to the rally. The two possible obstacles to the ongoing
Bitcoin and Ethereum rallies are the U.S. dollar recovery and the historical
performance of BTC in the month of September. Is The Weakening
U.S. Dollar Momentum Reversing? Analysts have generally attributed the
upsurge of both Bitcoin and gold to the fading dollar in recent months. In late July, the U.S. dollar plunged to a
two-year low due to the slowing economy and soaring virus cases. Since then, the U.S. dollar has
continuously declined. From March, within five months, the U.S. dollar index
dropped from 102.99 points to 91.75 points, by more than 10%. The weakening dollar seemingly fueled the
sentiment around alternative assets, including Bitcoin and gold. But, some analysts say that the decline of
the dollar is overexaggerated. On August 23, Capital Economics’ senior
economist Jonas Goltermann said the DXY does not depict the full picture. He described the “downfall” of the dollar
as a “greatly exaggerated” narrative. He noted that the U.S. dollar remains
the dominant reserve currency, with more stability over the euro and
renminbi. “Perhaps more importantly, there is no
obvious alternative to the dollar. The
next two largest economies, the euro-zone and China, are both smaller than
the US, and the euro (due to its still-fragile political underpinnings) and
the renminbi (due to China’s capital controls and unique political system)
have significant shortcomings as reserve currencies,” he said. The
U.S. dollar has fallen sharply since May, and it remains to be seen whether
the dollar could rebound at a key support area. The
recovery of the dollar could cause the uptrend of Bitcoin, gold, and other
cryptocurrencies to slow. Another
potential factor to consider is the historical performance of Bitcoin during
the month of September. Every monthly candle in the last three
years for the month of September closed as red. While the data is more coincidental
than cyclical, it would be compelling to see if the pattern breaks for the
first time in 4 years. The Momentum of Bitcoin And Ethereum
Remains Strong For now, the momentum of both Bitcoin and
Ethereum remains strong. Even at a high price point, the on-chain market
analysis firm Santiment said traders are undecided on whether to take profit.
“BTC jumped above $12k today for the first
time in 2 weeks, while $ETH hit a 25-month high of $485. Volume, especially
for #Ethereum, has soared as traders polarize and decide whether to #FOMO in
or profit take,” Santiment researchers said. Key on-chain data points also continuously
signal the start to an extended rally. Rafael Schultz-Kraft, the chief
technical officer at Glassnode, said the Bitcoin short-term holder net
unrealized profit and loss activity (NUPL) has been above zero for four
months. A positive NUPL historically “served as an
indication for BTC bull markets,” Kraft noted. Homework of
chapter 2 (due with first mid term) 1. Write down
the definition of M0, M1, M2 and M3; Which one is used as a measure of money
supply in this country? How much is it by the end of July 2020? 2. From Fed St.
Louis website, find the most recent charts of M1 money stock and M2 money
stock. http://research.stlouisfed.org/fred2/categories/24 Compare the two charts and discuss the
differences between the two charts. 3.What
is fractional banking system? Imagine that you deposited $5,000 in Bank
A. Reserve ratio is 0.1. Imagine that
the fractional banking system is fully functioning. After five cycles, what
is the amount that has been deposited and what is the total amount that has
been lent out? 4.
What is bitcoin? In your view, could bitcoin become a major global
currency? Could governments ban or destroy bitcoin? 5. What about other crypto? Some are really
cheap. /Do you plan to invest in them? Why or why not? 6. What are the Two Biggest Threats To The Ongoing Bitcoin And Ethereum Rallies
according to https://www.forbes.com/sites/youngjoseph/2020/09/01/bitcoin-dollar-ethereum/#358120e95939 |
(continuing
from above) Planted in
industrial Bushwick, a stone’s throw from the pizza mecca Roberta’s,
“headquarters” seemed an unlikely word. The front door was festooned with
graffiti and stickers; inside, the stairwells of the space appeared to have
been last renovated during the Coolidge administration. Just about three
years old, the ConsenSys network now includes more than 550 employees in 28
countries, and the operation has never raised a d0ime of venture capital. As
an organization, ConsenSys does not quite fit any of the usual categories: It
is technically a corporation, but it has elements that also resemble
nonprofits and workers’ collectives. The shared goal of ConsenSys members is
strengthening and expanding the Ethereum blockchain. They support developers
creating new apps and tools for the platform, one of which is MetaMask, the
software that generated my Ethereum address. But they also offer
consulting-style services for companies, nonprofits or governments looking
for ways to integrate Ethereum’s smart contracts into their own systems. The true test of the blockchain will revolve —
like so many of the online crises of the past few years — around the problem
of identity. Today your digital identity is scattered across dozens, or
even hundreds, of different sites: Amazon has your credit-card information
and your purchase history; Facebook knows your friends and family; Equifax
maintains your credit history. When you use any of those services, you are
effectively asking for permission to borrow some of that information about
yourself in order perform a task: ordering a Christmas present for your
uncle, checking Instagram to see pictures from the office party last night.
But all these different fragments of your identity don’t belong to you; they
belong to Facebook and Amazon and Google, who are free to sell bits of that
information about you to advertisers without consulting you. You, of course,
are free to delete those accounts if you choose, and if you stop checking
Facebook, Zuckerberg and the Facebook shareholders will stop making money by
renting out your attention to their true customers. But your Facebook or
Google identity isn’t portable. If you want to join another promising social
network that is maybe a little less infected with Russian bots, you can’t
extract your social network from Twitter and deposit it in the new service.
You have to build the network again from scratch (and persuade all your
friends to do the same). The blockchain
evangelists think this entire approach is backward. You should own your digital identity — which could include everything
from your date of birth to your friend networks to your purchasing history —
and you should be free to lend parts of that identity out to services as you
see fit. Given that identity was not baked into the original internet
protocols, and given the difficulty of managing a distributed database in the
days before Bitcoin, this form of “self-sovereign” identity — as the parlance
has it — was a practical impossibility. Now it is an attainable goal. A
number of blockchain-based services are trying to tackle this problem,
including a new identity system called uPort that has been spun out of
ConsenSys and another one called Blockstack that is currently based on the
Bitcoin platform. (Tim Berners-Lee is leading the development of a
comparable system, called Solid, that would also give users control over
their own data.) These rival protocols all have slightly different
frameworks, but they all share a general vision of how identity should work
on a truly decentralized internet. What would
prevent a new blockchain-based identity standard from following Tim Wu’s
Cycle, the same one that brought Facebook to such a dominant position?
Perhaps nothing. But imagine how that sequence would play out in practice.
Someone creates a new protocol to define your social network via Ethereum. It
might be as simple as a list of other Ethereum addresses; in other
words, Here are the public addresses of people I like and trust. That
way of defining your social network might well take off and ultimately
supplant the closed systems that define your network on Facebook. Perhaps
someday, every single person on the planet might use that standard to map
their social connections, just as every single person on the internet uses
TCP/IP to share data. But even if this new form of identity became
ubiquitous, it wouldn’t present the same opportunities for abuse and
manipulation that you find in the closed systems that have become de facto
standards. I might allow a Facebook-style service to use my social map to
filter news or gossip or music for me, based on the activity of my friends,
but if that service annoyed me, I’d be free to sample other alternatives
without the switching costs. An open identity standard would give ordinary
people the opportunity to sell their attention to the highest bidder, or
choose to keep it out of the marketplace altogether. Gutterman
suggests that the same kind of system could be applied to even more critical
forms of identity, like health care data. Instead of storing, say, your
genome on servers belonging to a private corporation, the information would
instead be stored inside a personal data archive. “There may be many
corporate entities that I don’t want seeing that data, but maybe I’d like to
donate that data to a medical study,” she says. “I could use my
blockchain-based self-sovereign ID to [allow] one group to use it and not
another. Or I could sell it over here and give it away over there.” The token
architecture would give a blockchain-based identity standard an additional
edge over closed standards like Facebook’s. As many critics have observed,
ordinary users on social-media platforms create almost all the content
without compensation, while the companies capture all the economic value from
that content through advertising sales. A token-based social network would at
least give early adopters a piece of the action, rewarding them for their
labors in making the new platform appealing. “If someone can really figure
out a version of Facebook that lets users own a piece of the network and get
paid,” Dixon says, “that could be pretty compelling.” Would that
information be more secure in a distributed blockchain than behind the
elaborate firewalls of giant corporations like Google or Facebook? In this
one respect, the Bitcoin story is actually instructive: It may never be
stable enough to function as a currency, but it does offer convincing proof
of just how secure a distributed ledger can be. “Look at the market cap of
Bitcoin or Ethereum: $80 billion, $25 billion, whatever,” Dixon says. “That means
if you successfully attack that system, you could walk away with more than a
billion dollars. You know what a ‘bug bounty’ is? Someone says, ‘If you hack
my system, I’ll give you a million dollars.’ So Bitcoin is now a
nine-year-old multibillion-dollar bug bounty, and no one’s hacked it. It
feels like pretty good proof.” Additional security would come from the
decentralized nature of these new identity protocols. In the identity system
proposed by Blockstack, the actual information about your identity — your
social connections, your purchasing history — could be stored anywhere
online. The blockchain would simply provide cryptographically secure keys to
unlock that information and share it with other trusted providers. A system with
a centralized repository with data for hundreds of millions of users — what
security experts call “honey pots” — is far more appealing to hackers. Which
would you rather do: steal a hundred million credit histories by hacking into
a hundred million separate personal computers and sniffing around until
you found the right data on each machine? Or just hack into one honey pot at
Equifax and walk away with the same amount of data in a matter of hours? As
Gutterman puts it, “It’s the difference between robbing a house versus
robbing the entire village.” So much of the
blockchain’s architecture is shaped by predictions about how that
architecture might be abused once it finds a wider audience. That is part of
its charm and its power. The blockchain channels the energy of speculative bubbles
by allowing tokens to be shared widely among true supporters of the platform.
It safeguards against any individual or small group gaining control of the
entire database. Its cryptography is designed to protect against surveillance
states or identity thieves. In this, the blockchain displays a familial
resemblance to political constitutions: Its rules are designed with one eye
on how those rules might be exploited down the line. Much has been
made of the anarcho-libertarian streak in Bitcoin and other nonfiat
currencies; the community is rife with words and phrases (“self-sovereign”)
that sound as if they could be slogans for some militia compound in Montana.
And yet in its potential to break up large concentrations of power and
explore less-proprietary models of ownership, the blockchain idea offers a
tantalizing possibility for those who would like to distribute wealth more
equitably and break up the cartels of the digital age. The blockchain
worldview can also sound libertarian in the sense that it proposes nonstate
solutions to capitalist excesses like information monopolies. But to believe in the blockchain is not
necessarily to oppose regulation, if that regulation is designed with
complementary aims. Brad Burnham, for instance, suggests that regulators
should insist that everyone have “a right to a private data store,” where all
the various facets of their online identity would be maintained. But
governments wouldn’t be required to design those identity protocols. They
would be developed on the blockchain, open source. Ideologically speaking,
that private data store would be a true team effort: built as an intellectual
commons, funded by token speculators, supported by the regulatory state. Like the
original internet itself, the blockchain is an idea with radical — almost
communitarian — possibilities that at the same time has attracted some of the
most frivolous and regressive appetites of capitalism. We spent our first
years online in a world defined by open protocols and intellectual commons;
we spent the second phase in a world increasingly dominated by closed
architectures and proprietary databases. We have learned enough from this
history to support the hypothesis that open works better than closed, at
least where base-layer issues are concerned. But we don’t have an easy route
back to the open-protocol era. Some messianic next-generation internet
protocol is not likely to emerge out of Department of Defense research, the
way the first-generation internet did nearly 50 years ago. Yes, the blockchain may seem like the very worst of
speculative capitalism right now, and yes, it is demonically challenging to
understand. But the beautiful thing about open protocols is that they can be
steered in surprising new directions by the people who discover and champion
them in their infancy. Right now, the only real hope for a revival of
the open-protocol ethos lies in the blockchain. Whether it eventually lives
up to its egalitarian promise will in large part depend on the people who
embrace the platform, who take up the baton, as Juan Benet puts it, from
those early online pioneers. If you think the internet is not working in its
current incarnation, you can’t change the system through think-pieces and
F.C.C. regulations alone |
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Chapter
3 Financial Instruments, Financial Markets, and Financial Institutions Part I: Examples and characteristics
of financial instruments Discussion: You have some extra bucks.
What will you do with the money? With extra bucks è Find a proper financial instruments è find a financial institution è trade in the market How does the Money Market work? (video)
Part II: Order types
|
COMPANY NAME |
PROPOSED SYMBOL |
EXCHANGE |
PRICE RANGE |
SHARES |
WEEK OF |
LSPD |
NYSE |
$32.31 |
11,650,000 |
9/7/2020 |
|
PIAI.U |
NYSE |
$10.00 |
30,000,000 |
9/7/2020 |
NEXT WEEK • 11 TOTAL
COMPANY NAME |
PROPOSED SYMBOL |
EXCHANGE |
PRICE RANGE |
SHARES |
WEEK OF |
AMWL |
NYSE |
$14.00
- $16.00 |
35,000,000 |
9/14/2020 |
|
BNL |
NYSE |
$17.00
- $19.00 |
33,500,000 |
9/14/2020 |
|
FROG |
Nasdaq |
$33.00
- $37.00 |
11,568,218 |
9/14/2020 |
|
MTCR |
Nasdaq |
$12.00
- $14.00 |
6,540,000 |
9/14/2020 |
|
OM |
Nasdaq |
$22.00
- $24.00 |
7,600,000 |
9/14/2020 |
|
PTVE |
Nasdaq |
$18.00
- $21.00 |
41,026,000 |
9/14/2020 |
|
SNOW |
NYSE |
$75.00
- $85.00 |
28,000,000 |
9/14/2020 |
|
STEP |
Nasdaq |
$15.00
- $17.00 |
17,500,000 |
9/14/2020 |
|
SUMO |
Nasdaq |
$17.00
- $21.00 |
14,800,000 |
9/14/2020 |
|
U |
NYSE |
$34.00
- $42.00 |
25,000,000 |
9/14/2020 |
|
VTRU |
Nasdaq |
$22.00
- $24.00 |
11,230,126 |
9/14/2020 |
In
Class Exercise part II
Multiple Choices
1. The market for equities is
predominantly a:
a. primary market.
b. market dominated by individual investors.
c. secondary market.
d. market dominated by foreign investors.
2. Primary markets:
a. involve the organized trading of outstanding
securities on exchanges.
b. involve the organized trading of outstanding
securities in the over-the-counter market.
c. involve the organized trading of outstanding
securities on exchanges and over-the-counter markets.
d. are where new issues (IPOs) are sold by
corporations to raise new capital.
By Published September 18, 2019
The Securities and Exchange Commission is looking to clear a path
for small investors to access the burgeoning market for private company
stocks. The effort could involve new rulemaking that would allow for the
creation of a hedge fund-like instrument that invests in pre-IPO shares
structured for the average retail investor, the Fox Business Network has
learned.
The SEC initiative is still in the discussion stages and its
timing of any implementation is unclear. But the talks follow recent remarks
made by SEC Chairman Jay Clayton, who said small investors should have access
to buying pre-IPO shares – a market that is open only to large institutional
investors and accredited individual investors who either have a net worth of
$1 million or make $200,000 annually.
The market for buying and selling pre-IPO shares is indeed
booming, which is why Clayton and SEC commissioners have taken up the matter.
They are trying to determine if a vehicle could be created to open such
securities to small investors. Last year, companies in the private market
raised roughly $3 trillion while public companies raised $1.8 trillion.
Market participants point out the gains are often greater in the
trading of pre-IPOs shares than some recent prominent initial public
offerings, such as ride-share provider Uber, which has floundered in its
public debut after racking up huge gains when Uber private shares traded in
the pre-IPO market.
"The SEC is seriously considering approving a new
investment vehicle for private shares," John Coffee, a Columbia law
school professor who specializes in financial issues, said.
“The mechanics are unclear but the SEC can either ask Congress
for legislation or adopt a rule that exempts its new vehicle from the
Investment Company Act of 1940,” Coffee added.
An SEC spokesman declined comment.
The SEC’s talks center on passing a rule that would create a new
investment vehicle that mirrors a hedge fund. But unlike hedge funds, it
would be open to non-accredited investors, according to people with knowledge
of the discussions. Small investors would gain access to the private market
by going through this fund-like vehicle, which would be comprised of a
diversified portfolio of pre-IPO companies in order to reduce investment
risk.
But not all market participants believe the effort is a good
idea. The SEC would demand additional disclosures from the companies
themselves, thus making the companies less likely to issue private shares,
much less public shares. The reason many companies are opting to remain in
the private market for years is the less stringent disclosure requirement mandated
by the SEC because investors are considered more sophisticated than so-called
mom-and-pop retail purchasers of stock.
“Part of why private companies can enjoy accelerated growth is
that they are free from the regulatory burden public companies face. In
addition, they are more efficient because their management teams are not
beholden to quarterly earnings and compensated based on a public share
price,” said Omeed Malik, the founder and CEO of Farvahar Partners, a
broker-dealer specializing in the private stock market.
“Allowing Main Street to invest in privately traded companies
sounds nice but the road to hell is paved with good intentions,” Malik said
in an interview on FBN’s Cavuto Coast to Coast. “Allowing retailer investors
to participate in private placement is a noble sentiment … but there are
significant ramifications,” he said in a subsequent interview.
Because the private markets have fewer regulations than public
markets, some analysts fear retail investors could be putting themselves at
greater risk without fully understanding the volatility of pre-IPO companies.
While there may be opportunities in private markets, investors are not
insulated from losses just because they get in on a company’s stock earlier.
Clayton has made serving the needs of small investors a
centerpiece of his agenda as SEC chairman, and people close to the commission
say he’s intent on opening the private market to small investors as part of
that effort.
In a Sept. 9 speech at the Economic Club of New York meeting,
Clayton said, “Twenty-five years ago, the public markets dominated the
private markets in virtually every measure.
Today, in many measures, the private markets outpace the public
markets, including in aggregate size.”
For discussion:
·
Do
you support this idea that the pre-IPO shares should be available to all
investors. Is that possible?
Homework ( DUE with first
midterm exam)
1. Check
three stocks listed above in the IPO table.
·
Follow these stocks and report their
performances one month after the IPO.
·
Summarize your findings.
2) Tesla is selling at $370 per share as of
9/10/2020. Do you suggest investing in Tesla? Why or why not?
3) Tesla will
issue new shares called secondary public offering (SEO). What is the impact
on stock price by this new offering?
Why?
Tesla Stock’s 3 Big Issues
After The Stock Split
For discussion: Now under $400. Time
to buy?
John NavinContributor
It’s hard to complain about stocks that go straight up,
more or less, in price. It’s the dream of every investor to find them and
then to brag endlessly about their genius in identifying them. Tesla TSLA +10.9% is the latest example of
slightly crazed buying in a single equity that nothing can hold back.
There’s no question that CEO Elon Musk is one of the great
business innovators, creating the first no-gasoline-needed car that found a
market and established a brand name. Those short sellers who question Tesla’s
long-term prospects keep getting frustrated by the stock’s ability to keep
reaching the sky.
Tesla
monthly price chart, 8 29 20.
STOCKCHARTS.COM
Monday’s stock split is a meaningless exercise: investors
end up with more shares for the same amount of money. Big deal. Tesla gets a
few headlines but nothing of substance is accomplished from the standpoint of
profitability or growth.
Meantime, here are 3 issues many of the car company’s most
enthusiastic supporters seem to want to ignore.
Tesla’s price/earnings ratio is insanely
and ridiculously high: 1,100. Come on now. The forward p/e, based on
something called “expected earnings,” is a mere 140, of course, but how much
more reasonable is that, really?
The Shiller p/e of the Standard and Poor’s 500 now
sits at 30 which by itself is
historically on the “rather high” side to begin with. The price/earnings
ratio for Apple AAPL +4% is 38. Microsoft MSFT +4.3% is coming in these days at
39.
Tesla’s multiple of 1,100 suggests investors believe that
Elon Musk will be bringing back gold from his mines on Mars by sometime next
year and that the value of the metals will be showing up on the company’s
bottom line right away.
This is not to say the price/earnings ratios are the key
to investing. It’s just one metric among many for determining valuation, but
it’s the most classically used of the metrics from Benjamin Graham and Warren
Buffett on down.
Competition to Tesla is here and it’s been here for awhile. High-end and
middle-brow electric and hybrid gas/electric powered can be purchased from a
number of established car makers.
Ford, General Motors GM -1.3% and Honda are involved.
Those taking direct aim at the firm Tesla grip on the real luxury market
include Porsche with the Taycan — and Lexus with their ES Hybrid.
While Musk has created the name brand that seems to most
clearly identify newness and style, history tends to demonstrate that others
eventually take on and meet the challenge of offering marketable alternatives
to the original concept.
Some Tesla investors have difficulty even comprehending
the idea of actual competition to their favorite, highly-profitable portfolio
addition. It may take months or years but highly competitive operations are
underway to grab market share away.
Hot stock syndrome. If you’ve been around for a few years, you’ve seen this
before: during the most heated phase of a bull market, one stock becomes so
highly recognized as the hottest one that everyone you meet knows its name
and the basics of its story. Right now, that’s Tesla.
Inside the Wall Street community and outside, it’s the
growth stock to end all growth stocks. Since
it just keeps going up (so far), analysts are pressured to include it among
their “buy” recommendations, so as not to be left behind.
Robinhood traders, many of them new to the stock market
and to trading, find in Tesla their dream of apparently endless profits. They
have yet to experience the other side of a bull market and confidently go in
with much less caution than might be merited.
Tesla
daily price chart, 8 29 20.
STOCKCHARTS.COM
On the arrival of Tesla’s 5-for-1 stock split, it’s
probably wise to take these factors into consideration. Can it keep going up
in price despite all of this? Of course it can. Hot stocks have a way of
continuing upward despite all obstacles until, finally, they don’t — welcome
to the stock market.
Sell up to $5
billion in stock amid its incredible rally
PUBLISHED TUE, SEP 1 20207:22 AM EDTUPDATED TUE, SEP 1 20204:06
PM EDT
Pippa Stevens@PIPPASTEVENS13
KEY POINTS
• Amid
Tesla’s record rise that has seen shares soar to new highs, the company said
it will sell up to $5 billion in stock.
• The
additional shares will be sold “from time to time” and “at-the-market”
prices, Tesla said in an SEC filing.
• It said
banks will sell shares based on directives from Tesla.
• Through
Monday’s close, the electric car maker has gained nearly 500% in 2020.
Amid Tesla’s incredible rise that has seen shares soar to
new highs, the electric auto maker
said Tuesday it will sell up to $5 billion in new stock.
The additional shares will be sold “from time to time” and “at-the-market” prices, Tesla said in a
filing with the Securities and Exchange Commission. It said banks will sell shares
based on directives from Tesla.
“We intend to use the net proceeds, if any, from this
offering to further strengthen our balance sheet, as well as for general
corporate purposes,” Tesla said.
The stock briefly traded in the green on Tuesday, but moved
lower throughout afternoon trading and ended the session 4.67% lower.
The decline hardly dents shares’ rapid appreciation this
year. Through Monday’s close, the electric car maker has gained nearly 500%
in 2020. In the last year, shares have gained 1,004% compared with the
S&P 500′s 20% rise.
Tesla’s run-up has only gained steam since the company
announced its 5-for-1 stock split on Aug. 11. In that time, Tesla shares have
rallied 81.3%. That gain includes a 12.6% pop on Monday, when the split took
effect. That rise came even though stock
splits are purely cosmetic, meaning nothing about the company’s underlying
business changes.
Tesla’s market
cap now stands around $464 billion meaning the new offering represents about
1% of the company’s value,
according to FactSet.
Wedbush analyst Dan Ives called the capital raise a “smart
move,” citing strong appetite among investors to “play the transformational
EV trend through pure play Tesla over the coming years.”
CEO Elon Musk is “raising enough capital to get the
balance sheet and capital structure to further firm up its growing cash
position and slowly get out of its debt situation, which throws the lingering
bear thesis for Tesla out the window for now,” Ives added. Wedbush has a
neutral rating on the stock and a base target of $380.
Part of Tesla’s share appreciation is due to the company
reporting its fourth straight quarter of profits in its July 22 report, which
qualifies the electric auto maker for inclusion in the S&P 500. Tesla
also posted better-than-expected second-quarter vehicle deliveries.
Still, the rate at which investors have piled into the
company has left many on the Street puzzled.
Miller Tabak chief market strategist Matt Maley warned
that shares are due for a pullback. Those “who buy stock in TSLA on the new $5bn equity distribution they
announced this morning are going to get burned,” he said.
“Even if this stock rallies a bit more over the next week
or two, it’s going to be trading at least 30% below today’s level before the
end of the year in our opinion,” he added.
On Monday night, RBC reiterated its underperform rating on
the stock, calling the automaker “fundamentally overvalued.” However, the
firm did raise its price target from $170 to $290.
Tesla last tapped capital markets in February, when it
announced a $2 billion common stock offering. The announcement came just two
weeks after Musk said during the company’s fourth quarter earnings call that
he had no intention of raising capital.
“We’re spending money as quickly as we can spend it
sensibly,” Musk said on Jan. 29. “We are not artificially limiting our
progress. Despite all that, we are still generating positive cash. In light
of that, it doesn’t make sense to raise money because we expect to generate
cash despite this growth level.”
- CNBC’s Fred Imbert contributed reporting.
Chapter
4: Future value, Present Value, and Interest Rate
Example1: A 5 year, 5% coupon bond, currently
provides an annual return of 3%. Calculate the price of the bond.
Example 2: Your cousin is entering medical school
next fall and asks you for financial help. He needs $65,000 each year for the
first two years. After that, he is in residency for two years and will be
able to pay you back $10,000 each year. Then he graduates and becomes a fully
qualified doctor, and will be able to pay you $40,000 each year. He promises
to pay you $40,000 for 5 years after he graduates. Are you taking a financial
loss or gain by helping him out? Assume that the interest rate is 5% and that
there is no risk.
Example 3: You are awarded $500,000 in a lawsuit,
payable immediately. The defendant makes a counteroffer of $50,000 per year
for the first three years, starting at the end of the first year, followed by
$60,000 per year for the next 10 years. Should you accept the offer if the
discount rate is 12%? How about if the discount rate is 8%?
Example 4: John is 30 years old at the beginning of
the new millennium and is thinking about getting an MBA. John is currently
making $40,000 per year and expects the same for the remainder of his working
years (until age 65). I f he goes to a business school, he gives up his
income for two years and, in addition, pays $20,000 per year for tuition. In
return, John expects an increase in his salary after his MBA is completed.
Suppose that the post-graduation salary increases at a 5% per year and that
the discount rate is 8%. What is miminum expected starting salary
after graduation that makes going to a business school a positive-NPV
investment for John? For simplicity, assume that all cash flows occur at the
end of each year
Homework
(just write down the PV equations – Due with the first mid term exam):
1. The Thailand Co. is considering the purchase of
some new equipment. The quote consists of a quarterly payment of $4,740 for
10 years at 6.5 percent interest. What is the purchase price of the
equipment? ($138,617.88)
2. The condominium at the beach that you want to
buy costs $249,500. You plan to make a cash down payment of 20 percent and
finance the balance over 10 years at 6.75 percent. What will be the amount of
your monthly mortgage payment? ($2,291.89)
3. Today, you are purchasing a 15-year, 8 percent
annuity at a cost of $70,000. The annuity will pay annual payments. What is
the amount of each payment? ($8,178.07)
4. Shannon wants to have $10,000 in an investment
account three years from now. The account will pay 0.4 percent interest per
month. If Shannon saves money every month, starting one month from now, how
much will she have to save each month? ($258.81)
5. Trevor's Tires is offering a set of 4 premium
tires on sale for $450. The credit terms are 24 months at $20 per month. What
is the interest rate on this offer? (6.27 percent)
6. Top Quality Investments will pay you $2,000 a
year for 25 years in exchange for $19,000 today. What interest rate are you
earning on this annuity? (9.42 percent)
7. You have just won
the lottery! You can receive $10,000 a year for 8 years or $57,000 as a lump
sum payment today. What is the interest rate on the annuity? (8.22
percent)
Summary of math and excel equations
Math
Equations
FV
= PV *(1+r)^n
PV
= FV / ((1+r)^n)
N
= ln(FV/PV) / ln(1+r)
Rate
= (FV/PV)1/n -1
Annuity:
N = ln(FV/C*r+1)/(ln(1+r))
Or
N = ln(1/(1-(PV/C)*r)))/ (ln(1+r))
EAR
= (1+APR/m)^m-1
APR
= (1+EAR)^(1/m)*m
NPV NFV calculator:
·
9/17 First Mid Term from 11am to 3pm
·
Take it online
·
50 T/F questions
·
Will be Posted on course introduction on
blackboard
Chapter 6 Bond Market
1. Cash flow of bonds
For example: a 3 year bond 10% coupon rate, draw its cash flow.
Introduction to
bond investing (video)
How Bonds Work (video)
2. Risk of Bonds
Class discussion: Is bond market risky?
Bond risk (video)
Bond risk –
credit risk (video)
Bond risk –
interest rate risk (video)
Bond risk – how
to reduce your risk (video)
3. Choices of investment in bonds
FINRA – Bond market information
http://finra-markets.morningstar.com/BondCenter/Default.jsp
Treasury Bond Auction and Market information
http://www.treasurydirect.gov/
Treasury Bond
Corporate Bond
Municipal Bond
International Bond
Bond Mutual Fund
TIPs
Class
discussion Topic I:
As a college student, which type of bonds shall you buy? Why?
Class discussion
Topics II
You can invest in junk bonds. Shall you? Or shall you not?
What is a high yield bond (Video)
Definition: A high yield bond – also known as a junk bond –
is a debt security issued by companies or private equity concerns, where the
debt has lower than investment grade ratings. It is a major component –
along with leveraged loans – of the leveraged finance market.(www.highyieldbond.com)
Everything
You Need to Know About Junk Bonds (video)
Updated Aug 17, 2019
For many investors, the term "junk bond" evokes thoughts of investment scams and high-flying financiers of the 1980s, such as Ivan Boesky and Michael Milken, who were known as "junk-bond kings." But don't let the term fool you—if you own a bond fund, these worthless-sounding investments may have already found their way into your portfolio. Here's what you need to know about junk bonds.
Junk Bonds
From a technical viewpoint, a junk bond is exactly the same as a regular bond. Junk bonds are an IOU from a corporation or organization that states the amount it will pay you back (principal), the date it will pay you back (maturity date), and the interest (coupon) it will pay you on the borrowed money.
Junk bonds differ because of their issuers' credit quality. All bonds are characterized according to this credit quality and therefore fall into one of two bond categories:
Investment
Grade – These bonds are
issued by low- to medium-risk lenders. A bond rating on investment-grade debt
usually ranges from AAA to BBB. Investment-grade bonds might not offer
huge returns, but the risk of the borrower defaulting on interest payments is
much smaller.
Although
junk bonds pay high yields, they also carry a higher-than-average risk
that the company will default on the bond. Historically, average yields on
junk bonds have been 4% to 6% above those for comparable U.S. Treasuries.
Junk bonds can be broken down
into two other categories:
You need to know a few things before you run out and tell
your broker to buy all the junk bonds he can find. The obvious
caveat is that junk bonds are high
risk. With this bond type, you risk the chance that you will never get
your money back. Secondly, investing in junk bonds requires a high degree of
analytical skills, particularly knowledge of specialized credit. Short and
sweet, investing directly in junk is mainly for rich and motivated
individuals. This market is overwhelmingly dominated by institutional
investors.
This isn't to say that junk-bond investing is strictly for the
wealthy. For many individual investors, using a high-yield bond
fund makes a lot of sense. Not only do these funds allow you to take
advantage of professionals who spend their entire day researching junk bonds,
but these funds also lower your risk by diversifying your investments across
different asset types. One important note: know how long you can commit your
cash before you decide to buy a junk fund. Many junk bond funds do not allow
investors to cash out for one to two years.
Also, there comes a point in time when the rewards of junk
bonds don't justify the risks. Any individual investor can determine this by
looking at the yield spread between junk bonds and U.S. Treasuries. As
we already mentioned, the yield on junk is historically 4% to 6% above
Treasuries. If you notice the yield spread shrinking below 4%, then it
probably isn't the best time to invest in junk bonds. Another thing to look
for is the default rate on junk bonds. An easy way to track this is by
checking the Moody's website.
The final warning is that junk bonds are not much different
than equities in that they follow boom and bust cycles. In the early 1990s,
many bond funds earned upwards of 30% annual returns, but a flood of defaults
can cause these funds to produce stunning negative returns.
Despite their name, junk bonds can be valuable investments for
informed investors, but their potential high returns come with the potential
for high risk.
For discussion:
·
What type of
investors should buy high yield bond?
·
What do
Moody bond ratings mean?
·
How do Moody
and other rating agencies rate bonds?
Defaults reach above 5%, from 1.3% bottom in November 2018
By JOYWILTERMUTH
Defaults on bonds issued by debt-laden
U.S. companies with speculative-grade ratings are on pace to reach a new high
this year for the post 2008 crisis era, according to Goldman Sachs analysts.
The bank has tracked more
than $36 billion of defaulted so-called “junk bonds” already in 2019, and there are likely to be more,
particularly in the energy sector, to eclipse the prior post crisis default
record of $43 billion in 2016, wrote Goldman analysts led by Lotfi Karoui in
a Thursday note to clients.
“Thus far, defaults have been highly concentrated among energy
issuers, a trend that reflects structural as opposed to cyclical challenges,” the Goldman analysts wrote. “The
lingering weakness in oil prices coupled with weak growth sentiment may push
issuers in other structurally-challenged sectors toward defaults.”
Oil field servicing company Weatherford International Ltd WFTIQ, -8.67%,
which filed for bankruptcy with $7.4 billion of high-yield debt, is the year’s second-largest default, after the massive default of
California’s Pacific Gas and Electric Company PCG, +5.80% on
$18.3 billion of debt in January, according to Moody’s
Investors Service.
In the case of Weatherford,
Moody’s said it expects to see bond recoveries of
35%-65% on roughly $5.85 billion of debt that the company hopes to slash
through its restructuring.
PG&E was considered an investment-grade credit, until it filed for bankruptcy following devastating
California wildfires in 2017 and 20180 left it facing billions in potential
liabilities.
This chart shows the dollar amount of defaulted U.S. high-yield bonds thus
far in 2019, which is approaching levels not seen since 2016, after Brent
crude oil prices plunged below $35 per barrel and put significant
pressure on the financial conditions of oil companies and exporters.
Goldman Sachs
Moody’s
said this week in a separate report that junk-bonds issued by companies in July
came with the worst protections yet for investors.
Check out: Junk bonds are getting worse and investors are starting to
take notice
At present, the three-month
trailing high-yield bond default rate is above 5% on an annualized basis, a
sharp jump from its 1.3% bottom in November 2018, according to Goldman
analysts.
By comparison, the default
rate traveled north of 14% for U.S. high-yield bonds in the aftermath of the
2007-2008 global financial crisis, according to Moody’s,
which said in July that its baseline forecast was for defaults to stay below
4% through July 2020.
Goldman analysts also don’t see defaults moving meaningfully higher from current
levels, absent a “full-blown recession,” which the bank’s U.S. economics
team doesn’t anticipate occurring in the near term.
Recession and trade war jitters rattled U.S. stocks this week,
although the major benchmarks managed to close higher on Friday, with the Dow
Jones Industrial Average DJIA, -0.36% adding
300 points, and the S&P 500 index SPX, -0.45% gaining
41 points and the Nasdaq Composite Index COMP, -0.33%
increasing by 308 points.
Investors have plenty of high-risk and so-called grey swan events to watch for, as
the third quarter draws closer.
In high-yield, a big focus
will be corporate earnings through year-end. Companies can end up in default
when earnings slump, making it harder for borrowers to keep up on debt
payments.
And with energy making up
14% of the closely-tracked Bloomberg Barclays U.S. high-yield bond Index,
Oxford Economics is keeping a close eye on the fortunes of energy companies.
“Our main source of worry is the fact that the improvement in
U.S. fundamentals since 2017 can be entirely attributed to the energy sector,” wrote Michiel Tukker, Oxford Economics’
global strategist in a note Friday.
“It is telling that oil hasn’t risen
despite OPEC cuts and tensions in the Gulf of Hormuz,”
Tukker added.
October Brent crude UK:BRNV19 finished
up 0.7% on Friday to $58.64 a barrel on ICE Futures Europe, but was still
sharply down from its two-year high of $86.29 on October 3, 2018, according
to FactSet data.
What’s
more, Tukker found that 18% of U.S. high-yield companies recently reported
negative hearings, the highest since the global financial crisis outside of
the oil price collapse in 2014 and 2015.
Tukker said that could drag
down the sector’s debt interest coverage ratios, a
measure of corporate earnings to interest expenses.
“With earnings outlook gloomy, we expect the ratio to fall
significantly going forward, bringing interest coverage ratios down rapidly.”
Home Work chapter 6 (due with the second mid term
exam):
1. Draw cash flow graph of a bond
with 5 years left to maturity 5% coupon rate.
2. Find Wal-Mart bond in FINRA website. Find
Microsoft bond with similar maturity date: http://finra-markets.morningstar.com/BondCenter/Default.jsp
·
Which
company’s bond is riskier? Why?
·
What is the
rating of each company’s bond?
·
Do you agree
with the ratings given by the rating agencies?
3. As a bond investor, do you plan to invest
in junk bond? Why or why not?
4. Among stocks, investment grade bonds, and
high yield bonds, which one do you want to invest in? Why? Please refer to
the articles read in class.
year |
high yield bond |
investment
grade bond |
stock |
1980 |
-1.00% |
2.71% |
32.50% |
1981 |
7.56% |
6.26% |
-4.92% |
1982 |
32.45% |
32.65% |
21.55% |
1983 |
21.80% |
8.19% |
22.56% |
1984 |
8.50% |
15.15% |
6.27% |
1985 |
26.08% |
22.13% |
31.73% |
1986 |
16.50% |
15.30% |
18.67% |
1987 |
4.57% |
2.75% |
5.25% |
1988 |
15.25% |
7.89% |
16.61% |
1989 |
1.98 |
14.53% |
31.69% |
1990 |
-8.46% |
8.96% |
-3.11% |
1991 |
43.23% |
16.00% |
30.47% |
1992 |
18.29% |
7.40% |
7.62% |
1993 |
18.33% |
9.75% |
10.08% |
1994 |
-2.55% |
-2.92% |
1.32% |
1995 |
22.40% |
18.46% |
37.58% |
1996 |
11.24% |
3.64% |
22.96% |
1997 |
14.27% |
9.64% |
33.36% |
1998 |
4.04% |
8.70% |
28.58% |
1999 |
1.73% |
-0.82% |
21.04% |
2000 |
-5.68% |
11.63% |
-9.11% |
2001 |
5.44% |
8.43% |
-11.89% |
2002 |
-1.53% |
10.26% |
-22.10% |
2003 |
27.94% |
4.10% |
28.68% |
2004 |
11.95% |
4.34% |
10.88% |
2005 |
2.26% |
2.43% |
4.91% |
2006 |
11.92% |
4.33% |
15.79% |
2007 |
2.65% |
6.97% |
5.49% |
2008 |
-26.17% |
5.24% |
-37.00% |
2009 |
54.22% |
5.93% |
26.46% |
2010 |
14.42% |
6.54% |
15.06% |
2011 |
5.47% |
7.84% |
2.11% |
2012 |
14.72% |
4.22% |
16.00% |
2013 |
7.53% |
-2.02% |
32.39% |
average |
16.98% |
8.43% |
13.22% |
standard
deviation |
35.25% |
7.02% |
17.22% |
kurtosis |
22.15 |
3.30 |
0.87 |
Skewness |
4.31 |
1.37 |
-0.92 |
5. Fed reduced interest rate. Do you think
that it is safer to invest in junk bond when interest rates are low? Or just
the opposite? Why or why not?
It’s
extremely challenging to find year-by-year returns for the high-yield bond
market, and that's odd when you think about it. This is an asset class with a
great deal of money invested in it. If you're interested in seeing how
high-yield bonds have performed over time, this table shows the return for
the category each year from 1980 through 2013. It includes its performance
relative to stocks as gauged by the S&P 500 Index, and relative to
investment-grade bonds as measured by the Barclays Aggregate Bond Index.
High yield
returns are represented by the Salomon Smith Barney High Yield Composite
Index from 1980 through 2002, and the Credit Suisse High Yield Index from
2003 onward.
Year |
HY
Bonds |
Investment-Grade |
Stocks |
1980 |
-1.00% |
2.71% |
32.50% |
1981 |
7.56% |
6.26% |
-4.92% |
1982 |
32.45% |
32.65% |
21.55% |
1983 |
21.80% |
8.19% |
22.56% |
1984 |
8.50% |
15.15% |
6.27% |
1985 |
26.08% |
22.13% |
31.73% |
1986 |
16.50% |
15.30% |
18.67% |
1987 |
4.57% |
2.75% |
5.25% |
1988 |
15.25% |
7.89% |
16.61% |
1989 |
1.98 |
14.53% |
31.69% |
1990 |
-8.46% |
8.96% |
-3.11% |
1991 |
43.23% |
16.00% |
30.47% |
1992 |
18.29% |
7.40% |
7.62% |
1993 |
18.33% |
9.75% |
10.08% |
1994 |
-2.55% |
-2.92% |
1.32% |
1995 |
22.40% |
18.46% |
37.58% |
1996 |
11.24% |
3.64% |
22.96% |
1997 |
14.27% |
9.64% |
33.36% |
1998 |
4.04% |
8.70% |
28.58% |
1999 |
1.73% |
-0.82% |
21.04% |
2000 |
-5.68% |
11.63% |
-9.11% |
2001 |
5.44% |
8.43% |
-11.89% |
2002 |
-1.53% |
10.26% |
-22.10% |
2003 |
27.94% |
4.10% |
28.68% |
2004 |
11.95% |
4.34% |
10.88% |
2005 |
2.26% |
2.43% |
4.91% |
2006 |
11.92% |
4.33% |
15.79% |
2007 |
2.65% |
6.97% |
5.49% |
2008 |
-26.17% |
5.24% |
-37.00% |
2009 |
54.22% |
5.93% |
26.46% |
2010 |
14.42% |
6.54% |
15.06% |
2011 |
5.47% |
7.84% |
2.11% |
2012 |
14.72% |
4.22% |
16.00% |
2013 |
7.53% |
-2.02% |
32.39% |
Keep a few historical factors in perspective
when you're looking at these returns. First, there was a much higher representation
of “fallen angels”—former issues
that fell into below-investment-grade territory—in
the early days of the high-yield investment-grade market than
there is today. There was a corresponding lower representation of issues from
the type of smaller companies that make up the bulk of the market now.
Second, all the down years for high yield were
accompanied by the economic slowdowns in 1980, 1990, 1994, and 2000, or by
financial crises in 2002 and 2008.
Third,
yields were much higher in the past than they are today. While absolute
yields spent much of the 2012–2013 period below 7.5
percent and they reached as low as the 5.2 to 5.4 percent range in April and
May 2013, these levels would have been unheard of in prior years. The 1980–1990 period generally saw yields in the mid-teens. Even at
the lows of the late 1990s, high-yield bonds still yielded 8 to 9 percent.
During the 2004–2007 interval, yields hovered near
the 7.5 to 8 percent level, which were record lows at the time.
High-yield bonds also paid a much higher yield than they do
now.
The
takeaway is twofold. High-yield bonds had higher return potential due to the
larger contribution from yield to total return, and there was more room
for price appreciation. Remember that bond prices and yields move in opposite
directions. As a result, people who
invest in the asset class today shouldn’t expect a
repeat of the type of returns shown above. Still, these numbers show that
high-yield bonds have delivered very competitive returns over
time.
The
Party’s Almost Over, Say High-Yield Bond Investors
By
Erik Sherman, July
15, 2019
The high-yield party has been
raging. But investors who stick around may have one heck of a hangover.
In recent weeks, the difference in yields between high-grade
investment or government bonds and low-grade, high-yield corporate bonds
dropped to 375 basis points. Often called junk bonds, companies with low
credit ratings
issue high-yield bonds for access to capital, although at a higher interest
rate than companies with good credit.
But risk needs the right amount of reward. The shift in yields meant only 0.375% in interest now separates the
safest bond investments from those issued by companies with poorer credit
(and a higher risk of default). Given the narrowing yield spread, several
prominent portfolio managers have decided it's time to count their winnings
and bail on high-yield bonds.
"As a credit debt holder, you've got no upside, you only
have downside [at this point]," says Pilar Gomez-Bravo, director of
fixed income Europe for MFS Investment Management. Even if technical signals
seem to indicate a rally, "at some stage you want to be prudent in your
risk taking with levels you're getting paid for. You enjoy the party, the
rally, the momentum, but you have to be diligent." Back in 2016, 30% of
the portfolio she oversees was high-yield. Now that's down to 10%.
"There is an expectation that the economy is slowing in the
United States" and around the globe, said Troy Snider, investment
adviser and principal at Bartlett Wealth Management. The possibility of a
rate cut in the Fed's July meeting is seen as proof and the Fed funds futures
are showing a 100% expectation of a cut then, according to a Fortune review
of data from Bloomberg. That means investors think the Fed will respond to
what it sees as a slowing economy by dropping rates in a stimulus attempt.
A slowing
economy tends to be disproportionately hard on high-yield bonds. The
amount of interest companies have to pay for new bonds, be it the first
issuance or to roll over and pay off old bonds, shoots up. Now there's more
money to be made by investors in buying a newly issued bond rather than
purchasing an existing one from a current holder. Investors who already hold
bonds can find themselves unable to offload existing holdings, as the market
chases more profitable assets.
"You kind of think about it as a hill," said Jeff
Garden, chief investment officer of Lido Advisors. "On the way up, when
rates are low, it's great because [the low rates are] stimulating the economy
and promoting growth. Things are looking up. The cost of business is
cheap." But once at the top, things again go downhill, with a slowing
economy and increasing rates. That worries investors—who doesn't like the
good times to continue?—and they now assume that additional rate cuts are
more signs of a slowdown.
This has left high-yield bonds are in an agitated state. In May,
$7 billion was pulled out of high-risk bonds, which shouldn't matter in a
trillion-dollar or larger market, according to Karissa McDonough, fixed
income strategist at People's United Advisors. A trading day that saw $10
billion shifts would be considered normal, she said.
But investors still reacted strongly. As a result, the interest spread between high-yield bonds and
time-matched Treasurys went up by 100 basis points, or 1 percentage
point, within six weeks. "The
spread reflects the extra yield that investors demand for a high yield bond
instead of an asset like a Treasury bond," she said.
Then in June, Powel signaled the Fed's dovish position toward
rates and another $7 billion came back into that market. Within a few weeks, the
spread dropped again by 70 basis points. "The idea that some small
amount flowing [into or out of] the market could move it to that degree tells
you is this asset class is very, very sensitive to liquidity and fund flows
and investor sentiment," McDonough said.
The
potential for rapid and nervous reaction now creates a risk in the
higher-yield and junk bond markets. The companies issuing the bonds typically
expect to roll them over, taking on new bond issuance and investors to pay
off the earlier batch. "If the market pulls back and capital is not as
easily accessible to these companies, it's difficult to roll over,"
McDonough said.
That
could drive up default rates, which hurt the overall results in
any portfolio, because the greater the number of defaults the lower the
average returns. At the same time, there is the dichotomy between the bond
markets and equities, which are high on assumptions of Fed rescue with rate
drops.
"Something is about to break [in the economy] and that's
why the Fed is cutting rates," Gomez-Bravo said. "When you take
that in the context of the credit market, you have to overlay [whether you
are] getting paid for default risk, for downgrade risk."
"Our fixed income holdings have almost exclusively been
high-yield for the better part of a decade," said Patrick McDowell, a
portfolio manager at Arbor Wealth Management. "We’ve done well with the
strategy relative to other types of fixed income. But we are dramatically
slowing our purchases."
Or, as Garden put it, "At this point in the year, when I
look at the numbers, I see no reason to hold onto them. I've had a very, very
healthy return, one that I don't expect to continue for the next six to 12
months. I don't expect the magnitude and trajectory of returns that I've seen
over the past few months to continue, so why bother?"
Some managers say that dumping
all high-yield bonds may not be necessary, but investors have to pick and
choose carefully and not depend on a high-yield bond ETF, an investment
fund type focused on high-yield bonds and often popular with investors who
want better performance than available in government bonds. "It's time
to be very selective," Gomez-Bravo said. "If you're going to have
high yield, choose the idiosyncratic risk that you like."
And don't forget to have aspirin at hand the next morning. Just
in case.
For discussion:
·
Why during the economy downturn, it is
suggested not to invest in high yield bond?
·
What is the spread between high yield bond
and investment grade bond?
·
How to pick high yield bond? What is high
yield bond ETF?
Chapter
7 Rating, Term structure
Part I: Credit
Rating Agency
Chapter
7 Rating Agency, Interest rate risk, yield curve (PPT)
The Big Short - Standard and Poors
scene --- This is how they worked
·
Found any conflict of interest between the investment bank and
S&P?
·
Who acts in good conscience, the lady representing the rating
agency, or the Investment Banker?
Three Major Rating Agencies
University: Bond rating (video)
For class discussion
o Who
are they?
o Are
they private firms or government agencies?
o How
bonds are rated?
o Do
we need rating agencies? Do you trust their ratings?
Category |
Definition |
|
|
AAA |
An
obligation rated 'AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong. |
|
|
AA |
An
obligation rated 'AA' differs from the highest-rated obligations only to a
small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong. |
|
|
A |
An
obligation rated 'A' is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its
financial commitment on the obligation is still strong. |
|
|
BBB |
An
obligation rated 'BBB' exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation. |
|
|
Obligations
rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant
speculative characteristics. 'BB' indicates the least degree of speculation
and 'C' the highest. While such obligations will likely have some quality
and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions. |
|
||
|
|||
|
|||
|
|||
|
|||
|
|||
|
|||
|
|||
CCC |
An
obligation rated 'CCC' is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the
event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation. For
class discussion: Why
would an investor buy junk bond? |
||
Sovereigns Rating (http://countryeconomy.com/ratings/)
– The lowest and the highest – Most recent
Country |
S&P |
Moody's |
Fitch |
AAA |
Aa1 |
AA+ |
|
N/A |
Aa1 |
|
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
AAA |
Aaa |
AAA |
|
B- |
Caa1 |
|
|
B- |
Caa1 |
B- |
|
B |
Caa2 |
B |
|
B- |
Caa2 |
|
|
|
Caa2 |
|
|
B- |
Caa3 |
CCC |
|
B- |
Caa3 |
CCC |
|
CCC |
Caa3 |
CC |
|
CCC |
Caa3 |
CCC |
Class discussion Topics
·
How much do you trust those rating agencies?
·
Are those rating agencies private or public
firms?
·
What factors should be considered when a
rating agency is evaluating a debt?
How credit agencies work(video)
Rating Conflicts (video) https://www.youtube.com/watch?v=-C5JW4I3nfU
FYI:
The
functions of rating agencies
Part II: Z Scores
How the credits are assigned?
(word file)
The Altman Z-score is the
output of a credit-strength test that helps gauge the likelihood of
bankruptcy for a publicly traded manufacturing company. The Z-score is based
on five key financial ratios that
can be found and calculated from a company's annual 10-K report.
The calculation used to determine the Altman Z-score is as follows:
where: Zeta(ζ)=The Altman Z-score
A=Working capital/total assets
B=Retained earnings/total assets
C=Earnings before interest and taxes (EBIT)/totalassets
D=Market value of equity/book value of total liabilities
E=Sales/total assets
Typically, a score below 1.8 indicates that a company is
likely heading for or is under the weight of bankruptcy. Conversely,
companies that score above 3 are less likely to experience bankruptcy.
From http://www.altmanzscoreplus.com/articles/AltmanZScorePlus_TSLA_Tesla_Motors_Inc.html
Evolution of Z-Series Scores
The
Z-score formula for predicting bankruptcy was published in 1968 by Dr. Edward
I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may
be used to predict the probability that a firm will go into bankruptcy within
two years. Z-scores are used to predict corporate defaults and an
easy-to-calculate control measure for the financial distress status of
companies in academic studies. The Z-score uses multiple corporate income and
balance sheet values to measure the financial health of a company.
The
Z-score is a linear combination of four or five common business ratios,
weighted by coefficients. The coefficients were estimated by identifying a
set of firms which had declared bankruptcy and then collecting a matched
sample of firms which had survived, with matching by industry and approximate
size (assets). Professor Altman applied the statistical method of
discriminant analysis to a dataset of publicly held manufacturers. The
estimation was originally based on data from publicly held manufacturers, but
has since been re-estimated based on other datasets for private
manufacturing, non-manufacturing and service companies. Z-Score applies to US
Manufacturing companies, Z'-Score applies to US Private Manufacturing
companies, and Z"-Score applies to all other companies (US
Non-Manufacturing and all Non-US companies). The original data sample
consisted of 66 firms, half of which had filed for bankruptcy under Chapter
7. All businesses in the database were manufacturers, and small firms with
assets of less than $1 million were eliminated. Dr. Altman found that the
ratio profile for the bankrupt group fell at -0.25 average, and for the
non-bankrupt group at +4.48 average.
Classification of Z-Series Scores
Z-Score
went through further development. Z'-Score and Z"-Score models were
added later.
Z-Score - US Public Manufacturing companies.
Z' Score - US Private Manufacturing.
Z" Score - US Non-Manufacturing and Foreign Firms
Z-Series Score Formula
The
original Z-score formula is as follows:
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to
the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects
the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating
efficiency apart from tax and leveraging factors. It recognizes operating
earnings as being important to long-term viability.
X4 = Market Value of Equity / Book Value of Total Liabilities. Adds market
dimension that can show up security price fluctuation as a possible red flag.
X5 = Sales / Total Assets. Standard measure for total asset turnover (varies
greatly from industry to industry).
Z' = 0.717X1 + 0.847X2 + 3.107X3 + 0.420X4 + 0.998X5, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to
the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects
the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating
efficiency apart from tax and leveraging factors. It recognizes operating
earnings as being important to long-term viability.
X4 = Book Value of Equity / Book Value of Total Liabilities. Adds market
dimension that can show up security price fluctuation as a possible red flag.
X5 = Sales / Total Assets. Standard measure for total asset turnover (varies
greatly from industry to industry).
Z" = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4 + 3.25, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to
the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects
the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating
efficiency apart from tax and leveraging factors. It recognizes operating
earnings as being important to long-term viability.
X4 = Book Value of Equity / Book Value of Total Liabilities. Adds market
dimension that can show up security price fluctuation as a possible red flag.
Z-Series Score Bands:
Z
- US Public Manufacturing - Below 1.81 is distress zone, above 2.99 is safe
zone
Z' - US Private Manufacturing - Below 1.23 is distress zone, above 2.9 is
safe zone
Z" - US Non-Manufacturing and Foreign Firms - Below 1.1 is distress
zone, and above 2.6 is safe zone (after discounting 3.25 from the score)
NOTE:
Net Working Capital (NWC), Sales, Retained Earnings (R/E), Book Value (BV) of
Equities, Book Value (BV) of Liabilities, Market Value (MV) of Equities,
Total Assets, Preferred Stock (P/S) figures are in millions.
Date Reported |
Z-Score |
Z"-Score |
Applicable |
Distress Zone |
NWC |
Sales |
RE |
BV Liabilities |
MV Equities |
BV Equities |
Total Assets |
Market Capital |
P/S |
Jun 30, 2019 |
1.5 |
3.1 |
Z-Score |
RED ZONE |
593.18 |
24,941.43 |
-6,331.64 |
24,722.14 |
38,617.99 |
7,150.46 |
31,872.6 |
38,617.99 |
0 |
Mar 31, 2019 |
1.28 |
2.47 |
Z-Score |
RED ZONE |
-1,564.98 |
22,593.98 |
-5,923.31 |
22,874.62 |
33,109 |
6,037.91 |
28,912.52 |
33,109 |
0 |
Dec 31, 2018 |
1.68 |
2.52 |
Z-Score |
RED ZONE |
-1,685.83 |
21,461.27 |
-5,317.83 |
23,426.01 |
50,867.83 |
6,313.6 |
29,739.61 |
50,867.83 |
0 |
Sep 30, 2018 |
1.64 |
2.2 |
Z-Score |
RED ZONE |
-1,854.83 |
17,523.64 |
-5,457.31 |
23,409.14 |
59,365.99 |
5,853.57 |
29,262.71 |
59,365.99 |
0 |
Jun 30, 2018 |
1.29 |
1.71 |
Z-Score |
RED ZONE |
-2,441.57 |
13,683.91 |
-5,768.83 |
22,642.89 |
55,045.98 |
5,267.11 |
27,910 |
55,045.98 |
0 |
Mar 31, 2018 |
1.48 |
1.89 |
Z-Score |
RED ZONE |
-2,266.44 |
12,471.23 |
-5,051.29 |
21,551.02 |
58,215.76 |
5,720.41 |
27,271.43 |
58,215.76 |
0 |
Sep 30, 2017 |
1.53 |
2.86 |
Z-Score |
RED ZONE |
599.79 |
10,755.13 |
-4,298.96 |
21,929.41 |
54,639.13 |
6,177.66 |
28,107.07 |
54,639.13 |
0 |
Jun 30, 2017 |
1.86 |
2.91 |
Z-Score |
RED ZONE |
-186.91 |
10,068.89 |
-3,679.58 |
19,461.59 |
57,609.45 |
6,582.11 |
26,043.71 |
57,609.45 |
0 |
Mar 31, 2017 |
2.06 |
3.17 |
Z-Score |
RED ZONE |
782.45 |
8,549.35 |
-3,343.19 |
18,892.64 |
61,970.27 |
6,161.09 |
25,053.73 |
61,970.27 |
0 |
Dec 31, 2016 |
1.38 |
3.14 |
Z-Score |
RED ZONE |
432.79 |
7,000.13 |
-2,875.9 |
16,750.17 |
36,900.19 |
5,913.91 |
22,664.08 |
36,891.41 |
8,784,000 |
Sep 30, 2016 |
1.86 |
3 |
Z-Score |
RED ZONE |
1,090.02 |
5,929.88 |
-2,875.9 |
9,911.91 |
29,383.68 |
2,680.49 |
12,592.4 |
29,383.68 |
0 |
Jun 30, 2016 |
2.02 |
3 |
Z-Score |
RED ZONE |
1,437.3 |
4,568.23 |
-2,897.78 |
9,348.66 |
32,561.82 |
2,520.29 |
11,868.95 |
32,561.82 |
0 |
Mar 31, 2016 |
1.91 |
1.86 |
Z-Score |
RED ZONE |
51.84 |
4,253.19 |
-2,604.59 |
8,221.34 |
29,392.54 |
970.37 |
9,191.7 |
29,392.54 |
0 |
Tesla Altman Z-Score Calculation (https://www.gurufocus.com/term/zscore/TSLA/Altman%252BZ-Score/Tesla%2BInc)
Altman Z-Score model is an accurate forecaster
of failure up to two years prior to distress. It can be considered the
assessment of the distress of industrial corporations.
Tesla's Altman Z-Score for today is calculated with this formula:
Z |
= |
1.2 |
* |
X1 |
+ |
1.4 |
* |
X2 |
+ |
3.3 |
* |
X3 |
+ |
0.6 |
* |
X4 |
+ |
1.0 |
* |
X5 |
= |
1.2 |
* |
0.0804 |
+ |
1.4 |
* |
-0.1573 |
+ |
3.3 |
* |
0.0331 |
+ |
0.6 |
* |
14.6109 |
+ |
1.0 |
* |
0.6741 |
|
= |
9.43 |
* All numbers are in millions except for per
share data and ratio. All numbers are in their local exchange's currency.
GuruFocus does not calculate Altman Z-Score when X4 or X5 value is 0.
Trailing Twelve
Months (TTM) ended in Jun. 2020:
Total Assets was $38,135 Mil.
Total Current Assets
was $15,336 Mil.
Total Current
Liabilities was $12,270 Mil.
Retained Earnings was $-6,000 Mil.
Pre-Tax Income was 150 + 70 + 174 + 176 = $570 Mil.
Interest Expense was -170 + -169 + -170 + -185 = $-694 Mil.
Revenue was 6036 + 5985 + 7384 + 6303 = $25,708 Mil.
Market Cap (Today) was $400,498 Mil.
Total Liabilities was $27,411 Mil.
X1 |
= |
Working
Capital |
/ |
Total Assets |
||
= |
(Total Current Assets - Total Current Liabilities) |
/ |
Total Assets |
|||
= |
(15336
- 12270) |
/ |
38135 |
|||
= |
0.0804 |
|||||
X2 |
= |
Retained Earnings |
/ |
Total Assets |
||
= |
-6000 |
/ |
38135 |
|||
= |
-0.1573 |
X3 |
= |
Earnings
Before Interest and Taxes |
/ |
Total Assets |
|
= |
(Pre-Tax Income - Interest Expense) |
/ |
Total Assets |
||
= |
(570
- -694) |
/ |
38135 |
||
= |
0.0331 |
||||
X4 |
= |
Market
Value Equity |
/ |
Book
Value of Total Liabilities |
|
= |
Market Cap |
/ |
|||
= |
400498.053 |
/ |
27411 |
||
= |
14.6109 |
X5 |
= |
Revenue |
/ |
Total Assets |
= |
25708 |
/ |
38135 |
|
= |
0.6741 |
The zones of discrimination were as such:
Distress Zones - 1.81 < Grey Zones <
2.99 - Safe Zones
Tesla has a Altman
Z-Score of 9.43 indicating it is in Safe Zones.
Study by Altman found that companies that
are in Distress Zone have more than 80% of chances of bankruptcy in two
years.
Tesla (NAS:TSLA) Altman
Z-Score Explanation
X1: The
Working Capital/Total Assets (WC/TA) ratio is a measure of the net liquid
assets of the firm relative to the total capitalization. Working capital is
defined as the difference between current assets and current liabilities.
Ordinarily, a firm experiencing consistent operating losses will have
shrinking current assets in relation to total assets. Altman found this one
proved to be the most valuable liquidity ratio comparing with the current
ratio and the quick ratio. This is however the least significant of the five
factors.
X2:
Retained Earnings/Total Assets: the RE/TA ratio measures the leverage of a firm. Retained
earnings is the account which reports the total amount of reinvested earnings
and/or losses of a firm over its entire life. Those firms with high RE,
relative to TA, have financed their assets through retention of profits and
have not utilized as much debt.
X3,
Earnings Before Interest and Taxes/Total Assets (EBIT/TA): This ratio is a measure of the true
productivity of the firm's assets, independent of any tax or leverage
factors. Since a firm's ultimate existence is based on the earning power of
its assets, this ratio appears to be particularly appropriate for studies
dealing with corporate failure. This ratio continually outperforms other
profitability measures, including cash flow.
X4,
Market Value of Equity/Book Value of Total Liabilities (MVE/TL): The measure shows how much the firm's
assets can decline in value (measured by market value of equity plus debt)
before the liabilities exceed the assets and the firm becomes insolvent.
X5,
Revenue/Total Assets (S/TA): The capital-turnover ratio is a standard financial ratio
illustrating the sales generating ability of the firm's assets.
Homework of
chapter 7 part I: (Due with the second mid term exam)
1.
Who are the top three rating agencies? How do rating agencies make money?
What do the rating agencies look for?
2.
What is Z score? Find the Z scores of Wal-Mart, Apple, and Delta
Airline and draw a conclusion. For
example, you can find Delta’s z score at https://www.gurufocus.com/term/zscore/DAL/Altman-Z-Score/Delta-Air-Lines-Inc
3.
From Tesla’s z score table, what can you conclude? Do you think that
Tesla might be bankrupt in the near future based on its z score? Why or why
not? Note that the z score of Tesla is 9.43 as of 9/25/2020.
From https://www.gurufocus.com/term/zscore/TSLA/Altman%252BZ-Score/Tesla%2BInc
NAS:TSLA'
s Altman Z-Score Range Over the Past 10 Years
Min: -3.22 Med: 1.93 Max: 9.22
Current: 9.22
Competitive Comparison Data
|
|||
$1 Trillion of
Corporate Bonds Today, Downgrades Tomorrow
The fastest-ever borrowing binge was necessary but will
inevitably weigh down credit ratings.
By Brian Chappatta
May 28, 2020,
12:00 PM EDT
The amount of new debt issued this year in the
U.S. investment-grade corporate bond market will reach $1 trillion today, by
far the fastest pace in history.
The implications
of that milestone depend on how you look at it.
For businesses
that had been ravaged by the coronavirus pandemic and the ensuing nationwide
lockdowns, access to capital markets was a lifeline to get through the worst
of the economic collapse. Sure, Carnival
Corp. had to offer interest rates like
a junk-rated borrower and Boeing Co. needed to include a so-called coupon step-up
provision to offset jitters that it could lose
its investment grades. But, in the words of Federal Reserve Chair Jerome
Powell, these deals avoided turning “liquidity problems into solvency
problems” for brand-name American companies.
It’s worth
remembering that until the Fed stepped
in with extraordinary support for credit markets, averting widespread
failures was far from guaranteed. Investors pulled a staggering $35.6
billion and $38 billion from investment-grade funds in the weeks ended March
18 and March 25, respectively. Before 2020, the previous record was $5.1
billion of outflows. I wrote on March 19 that bond markets were veering
into a vicious cycle that
could get ugly in a hurry — four days later, the Fed announced what would end up becoming a $750 billion
backstop for corporate America.
Now, the Fed
hasn’t actually had to buy any individual bonds yet, a fact that Powell
seems proud to share. “We may have to be lending money to those
companies, but even better, they can borrow themselves now, and a lot of that
has been happening and that’s a really good thing,” he said during May 19
testimony before the Senate Banking Committee.
Most people would probably agree with that assessment, at least for the immediate future as the country grapples with restarting the world’s largest economy. But what about the longer-term view?
Here, the rampant borrowing paints a more sobering picture. As of late April, 1,287 issuers worldwide rated between AAA and B- by S&P Global Ratings were considered at risk of a potential downgrade, up from 860 in March and 649 in February. That surpasses the previous all-time high set in 2009. “Generally, we expect heavy credit erosion in coming months as issuers, especially those in the lower-rated spectrum come under heavy fire from poor earnings, continued difficulties in managing cost structures, and market volatility creating limited funding opportunities,” said Sudeep Kesh, head of S&P’s credit markets research.
That’s bad
enough, but doesn’t even strike at the heart of the issue. Last year was supposed to be the
beginning of a broad “debt diet” among companies that borrowed huge sums to
finance mergers and acquisitions during the longest expansion in U.S. history.
That didn’t end up taking place on a wide scale. Even a success story
like AT&T Inc., which made headway in trimming its debt
stack, still found itself back in the bond market
recently, borrowing $12.5 billion on May 21 in what was the
biggest deal since Boeing’s $25 billion blockbuster offering.
When it comes to
companies directly impacted by the coronavirus pandemic or structural changes
to their industries, the “big three” of S&P, Moody’s Investors Service
and Fitch Ratings haven’t shied away from taking action. Ford Motor
Co., Kraft Heinz Co., Macy’s Inc. and Occidental Petroleum Corp. are
just a few of the “fallen angels” that lost their investment grades
earlier this year.
The rating companies haven’t
been quite as keen to react to high leverage metrics. I frequently refer back
to this feature from Bloomberg News’s Molly
Smith and Christopher Cannon, which found that of the 50 biggest corporate
acquisitions in the five years through October 2018, more than half of the acquiring companies increased their leverage to
a level that would seemingly merit a junk rating but remained investment
grade on the assumption that they’d take that
leverage down in the coming years.
Those
expectations seemed ambitious in 2018, when the economy was seemingly
invincible. Now, no one can truly expect companies to focus on
right-sizing their debt. Corporate
leaders are rightfully eager to raise cash to get to the other side of the
pandemic, especially with all-in yields not far off from record lows. The
vast majority of the $1 trillion in borrowing so far this year was by no
means imprudent.
In the years
ahead, however, the overhang from this
issuance spree will inevitably weigh down credit ratings. A company with more debt presents a
greater risk of missed interest payments than if it had fewer fixed
obligations. Fortunately, for much
of the previous expansion, firms had no issue finding investors willing
to buy their long-term securities. That practice of rolling over debt and
extending maturities might very well be the norm in the months and years
ahead, too.
Still, if the
first five months of 2020 are any indication, investment-grade bondholders
will have to get comfortable with even more bloated balance sheets and the
prospect of further credit downgrades. For better or worse, with the
confidence that the Fed has their back, that seems like a risk investors
are willing to take.
For discussion:
·
Why do firms borrow so much money?
·
The more debt the firm has, the riskier the firm will be, and
the lower its debt will be rated. And it will be more likely that the bond will
be down-graded, resulting a selloff of the bond. Right?
Years of reform failed to alter rating agency business
models blamed for crisis
·
·
Author Zach Fox Sophia Furber
After inflated ratings
played a critical role in the 2008 financial crisis, policymakers across the
world called for more competition in credit ratings and changes to agencies'
business models. Ten
years after the crisis, rating agencies make money the same way, and the top
three companies are as dominant as ever.
The U.S. government's 2011 post-mortem report on the crisis called the
rating agencies' actions "essential cogs in the wheel of financial
destruction." When European regulators unveiled a suite of rules for
ratings agencies, they cited the role of ratings in both the 2008 crisis and
the European sovereign debt crisis. Policymakers
from both continents argued that the agencies' very business models were
central to the failures, reasoning that since issuers paid for ratings of
their own securities, agencies "felt pressured" to give high
ratings even though emails showed ratings analysts knew the housing market
was a "house of cards."
While rating agencies
stress they have taken steps to improve methodologies and transparency, their
business models remain effectively unchanged, and the largest rating agencies retain dominant market share. Data
from the U.S. Securities and Exchange Commission show the "big
three" rating agencies — S&P
Global Inc. unit S&P Global Ratings, Moody's Corp. and Fitch Ratings —
accounted for 94.4% of all rating agency revenue in 2016.
"It seems strange to think that despite their role in the
financial crisis and the billions of dollars of losses suffered by investors
and taxpayers, the business model of rating agencies remains unchanged,"
Dominic Lindely, director of policy at London-based New City Agenda, a
financial services think tank focused on improving social value in the
financial services industry, wrote in an email.
Efforts to change the business model
In the U.S., the Dodd-Frank Act sought to mitigate the conflict of
interest in the agencies' business models by encouraging unsolicited ratings — ratings from agencies that were not
paid by the security's issuer. There were two significant mechanisms: the
Franken Amendment and a disclosure website.
Dodd-Frank directed the SEC to study business models for
"nationally recognized" rating agencies — a crucial certification
that is required for financial firms investing in securities. If the SEC
could not recommend an alternative business model, the Franken Amendment
dictated the establishment of a board that randomly assigns securities to
rating agencies. The SEC produced a
study of various business models and held a roundtable discussion on the
topic in 2013, but it did not recommend a specific business model and
declined to establish a random-assignment board. The issue has received
no political attention in recent years, and the driving force behind the
amendment, Sen. Al Franken, D-Minn., has resigned following a sexual
harassment scandal.
"We're doing new financial regulatory reforms right now. How
about looking at ratings agencies again? But there doesn't seem to be any
appetite for that," said Marc Joffe, a senior policy analyst for
libertarian think tank Reason Foundation who recently authored a report
calling rating agencies the
"weakest link" in the financial system.
The law also required
greater transparency from rating agencies, mandating the disclosure of the
methodology behind ratings as well as specific data used to determine the
rating. An SEC rule forces rating agencies to
disclose data on password-protected websites accessible by competitors. The
idea was that other agencies would access the data and issue an unsolicited
rating, serving as a check against any ratings that might be overly
accommodating to issuers. The websites are operational, but industry
observers say they are rarely used and unsolicited ratings remain
non-existent.
"It creates a lot of bother for everyone in structured finance,
but it never created its intended effect of unsolicited ratings," said
Mark Adelson, a former chief credit officer in charge of ratings
methodologies for Standard & Poor's Ratings Services who is now editor of
The Journal of Structured Finance.
In Europe, regulators increased oversight of rating agencies and
forced methodology changes. The European Commission also issued rules meant
to decrease investors' reliance on ratings. But the top three rating agencies maintain a dominant presence in
Europe, too, with a 93.0% market share as of December 2017.
Without a market for
unsolicited ratings, rating agencies continue to use the issuer-paid model. Some ratings agencies have tried to focus on payments from
subscribers rather than issuers, but success has proven elusive. Kroll Bond
Rating Agency launched in 2009 with the goal of a subscription-based model
but began allowing issuer-paid ratings due to market pressure. Egan-Jones
Ratings Company has also promoted its subscription-based approach, but its
market share remains tiny. Media representatives for both Kroll and
Egan-Jones did not respond to requests for comment.
What has changed
While regulations have not spurred a market for unsolicited ratings,
there have been changes. The law led
to several SEC rules, which have required ratings agencies to be more
transparent in how they determine ratings. Other rules require agencies standardize
so that a rating of "AAA" on a structured finance product matches a
rating of "AAA" on corporate finance. The 2011 governmental
report on the crisis noted that 83% of all mortgage securities rated AAA in
2006 were ultimately downgraded. In 2009, S&P Global Ratings downgraded
just 8.6% of AAA-rated corporates to AA ratings.
"We have strengthened our independence from potential issuer
influence, improved our methodologies, increased our monitoring of global
credit risks, and have enhanced our regulatory compliance and analytical
quality," wrote John Piecuch, a spokesman for S&P Global Ratings, in
an email. Media representatives from Moody's and Fitch declined to comment.
The changes are evident: Documents published after the crisis show
more detail in how the agencies calculate risk and include examples of
hypothetical companies or issuance.
" Comparability and transparency were the
watchwords that everything else was built off of," said Adelson, who was
tasked with many of the post-crisis changes at S&P.
For rating agency critics,
however, the changes are insufficient. Bill
Harrington, a former credit officer at Moody's, said ratings agencies continue to operate with impunity, issuing
substandard ratings, enabled by a compliant SEC that suspended a Dodd-Frank
provision that would have increased legal liability for inaccurate ratings.
"The SEC will not go near the content of ratings or
methodologies. It picks and chooses which rules to enforce and which rules
not to enforce," Harrington, who is now a senior fellow at the nonprofit
Croatan Institute said. "It leaves ratings agencies unaccountable."
Whether the post-crisis
changes have yielded ratings that are more robust will not be known until the
ratings are tested by a credit downturn.
Adelson said ratings agencies clearly have invested heavily in updating
methodologies, changes that have generally improved the transparency and
consistency of ratings.
Consistency for structured finance ratings has been a goal ever since
the crisis, which was driven, in part, by highly rated collateralized debt
obligations that ultimately collapsed. In 2008, Moody's downgraded 91% of
single-family CDOs, but it only cut 37% of residential mortgage-backed
securities. Ann Rutledge, CEO of CreditSpectrum, an unlicensed credit rating
agency, said the changes instituted by Dodd-Frank failed to address those
core issues in structured finance.
"I think the whole thrust
of Dodd-Frank was legal and moral," she said. "And the problems
leading to the crisis were technical."
S&P Global Ratings and S&P Global Market Intelligence are both
owned by S&P Global Inc.
For
discussion:
1.
Transparency is suggested. If only
z score is used to rate securities, transparency should not be an issue.
Right?
2.
So the model used to rate
securities should be more complicated than a simple z score. So do you think
that the rating agencies should reveal their methodologies for rating bonds?
3.
Do you trust the ratings given by the
three rating agencies?
Part
III: Yield curve (or Term structure)
·
What is yield curve?
( http://www.yieldcurve.com/MktYCgraph.htm)
Market watch on Wall Street Journal has daily yield
curve and interest rate information.
http://www.marketwatch.com/tools/pftools/
|
|||||||||||
For Discussion |
|||||||||||
·
Why do we need yield
curve?
·
What can yield curve
tell us?
https://www.gurufocus.com/yield_curve.php
As of 10/05/2020
1-month yield |
0.09% |
1-year
yield |
0.12% |
2-year
yield |
0.14% |
10-year
yield |
0.78% |
30-year
yield |
1.57% |
For discussion:
·
Compare the yield
curves in the three years. What do you conclude?
·
2020 Oct’s yield
curve is steeply upward sloping. What does it imply?
·
Do you believe the
economic forecast based on yield curve? (refer to the following)
Summary of Yield Curve Shapes and Explanations
Normal Yield Curve
When bond investors expect the economy to hum along at normal rates of growth
without significant changes in inflation rates or available capital, the
yield curve slopes gently upward. In the absence of economic disruptions,
investors who risk their money for longer periods expect to get a bigger
reward — in the form of higher interest — than those who risk their money for
shorter time periods. Thus, as maturities lengthen, interest rates get
progressively higher and the curve goes up.
Steep Curve – Economy is improving
Typically the yield on 30-year Treasury bonds is three percentage points
above the yield on three-month Treasury bills. When it gets wider than that —
and the slope of the yield curve increases sharply — long-term bond holders
are sending a message that they think the economy will improve quickly in the
future.
Inverted Curve – Recession is coming
At first glance an inverted yield curve seems like a paradox. Why would
long-term investors settle for lower yields while short-term investors take
so much less risk? The answer is that long-term investors will settle for
lower yields now if they think rates — and the economy — are going even lower
in the future. They're betting that this is their last chance to lock in
rates before the bottom falls out.
Flat or Humped Curve
To become inverted, the yield curve must pass through
a period where long-term yields are the same as short-term rates. When that
happens the shape will appear to be flat or, more commonly, a little raised
in the middle.
Unfortunately, not all flat or humped curves turn into fully
inverted curves. Otherwise we'd all get rich plunking our savings down on
30-year bonds the second we saw their yields start falling toward short-term
levels.
On the other hand, you shouldn't discount a flat or humped curve
just because it doesn't guarantee a coming recession. The odds are still
pretty good that economic slowdown and lower interest rates will follow a
period of flattening yields.
5 things investors need to
know about an inverted yield curve
Published: Aug 28, 2019 9:43 a.m. ET
By
WILLIAM WATTS
The 10-year yield fell below the 2-year
yield for the first time since June 2007
The main measure of the yield curve briefly
deepened its inversion on Tuesday — with the yield on the 10-year Treasury
note extending its drop below the yield on the 2-year note — underlining
investor worries over a potential recession.
But while
inversions are seen as a reliable indicator of an economic downturn,
investors may be pushing the panic button prematurely. Here’s a look at what
happened and what it might mean for financial markets.
What’s the
yield curve?
The yield curve is a line plotting out yields
across maturities. Typically, it slopes upward, with investors demanding more
compensation to hold a note or bond for a longer period given the risk of
inflation and other uncertainties.
An inverted curve can be a source of concern for
a variety of reasons: short-term rates could be running high because overly
tight monetary policy is slowing the economy, or it could be that investor
worries about future economic growth are stoking demand for safe, long-term
Treasurys, pushing down long-term rates, note economists at the San
Francisco Fed, who have led research into the relationship between the curve
and the economy.
They noted in an August 2018 research paper that,
historically, the causation “may have well gone both ways” and that “great
caution is therefore warranted in interpreting the predictive evidence.”
What just
happened?
The yield
curve has been flattening for some time. A global bond rally in the wake of rising
trade tensions pulled down yields for long-term bonds. The 10-year Treasury
note yield TMUBMUSD10Y, -1.05% fell
as low as 1.453% on Wednesday, trading around 4 basis points below the yield
on the 2-year note peerTMUBMUSD02Y, -0.25%.
The inversion
on this widely-watched measure of the yield curve’s slope had already taken
place two weeks ago, when signs of economic weakness across the globe drew
investors into haven
Why does it
matter?
The
2-year/10-year version of the yield curve has preceded each of the past seven
recessions, including the most recent slowdown between 2007 and 2009.
Other yield
curve measures have already inverted, including the widely-watched
3-month/10-year spread used by the Federal Reserve to gauge recession
probabilities.
Is recession
imminent?
A recession
isn’t a certainty. Some economists have argued that the aftermath of
quantitative easing measures that saw global central banks snap up government
bonds and drive down longer term yields may have robbed inversions of their reliability
as a predictor. According to this school of thought, negative bond yields in
Europe and Japan have forced yield-starved investors to the U.S.,
artificially depressing long-term Treasury yields.
Some Fed
policy makers, including New York Fed President John Williams,
have also periodically questioned the overwhelming importance placed by
market participants on the yield curve, seeing it as only one measure among
many that could point to economic distress.
Others say an
inversion of the yield curve reflects when the bond-market is expecting the
U.S. central bank to set off on an extended easing cycle. This pent-up
anticipation drives long-term bond yields below their short-term peers. But
if the Fed cuts rates in a speedy fashion and successfully prevents an
economic downturn, the yield curve’s inversion this time around may turn out
to be a false positive.
And even if
the yield curve does point to a future recession, investors might not want to
panic immediately. From 1956, past recessions have started on average around
15 months after an inversion of the 2-year/10-year spread occurred, according
to Bank of America Merrill Lynch.
Are market
worries overdone?
Some investors
argued that until other recession indicators, such as the unemployment rate,
start blinking red, it’s probably premature to press the panic button.
“It’s a
recession indicator among many others, though the yield curve may be flashing
red, others are not,” said Adrian Helfert, director of multi-asset portfolios
at Westwood Holdings Group, in an interview with MarketWatch.
Homework chapter 7 part II (due with the second mid-term exam):
1.
Based on “ yield curve inversion: What is it,
why it matters and what to do now?”, please answer the following questions.
·
What does inverted yield
curve usually indicate to the market? Why?
·
What are the causes of
the current inverted yield curve this time?
·
What is the advice of the
author based on this article?
Mar
3, 2020, 3:56 pm EDT
Amid the Dow Jones Industrial Average dropping 2,000
points in two days (its biggest two day drop, ever) on
concerns that the coronavirus is rapidly expanding outside of China and
turning into a pandemic, you probably missed something that would otherwise
be dominating financial headlines everywhere. That is, in mid-February, Wall
Street’s favorite recession indicator — a yield curve inversion — appeared,
again, for the second time in seven months.
A yield curve inversion happens when
long-term interest rates fall below short-term interest rates, indicative
that investor demand for long-term fixed income instruments is unusually high
and expectations for near-term economic growth are unusually low.
It’s a
scary sign. A yield curve inversion has successfully predicted every U.S.
recession since 1930.
So, with the yield curve inverted, the coronavirus gradually
turning into a global pandemic, and the bull market in its eleventh year, is
it time to call it one heck of a run, and take profits off the table?
I don’t think so. Not yet, at least.
But, in order to understand why, let’s take a step back and
answer some basic questions. What exactly is a yield curve inversion? Why
does it predict recessions? What normally happens after an inversion? What’s
different this time around?
Let’s answer all those questions, and more, in this guide to
understanding a yield curve inversion and what it means for your money today.
The
yield curve inverts when long-term interest rates fall below short-term ones.
That is
an abnormal circumstance in financial markets.
Normally, short-term interest rates are below long-term interest rates,
indicative of the fact that investors require more return for keeping their
money tied up for longer.
But, when investors expect that a slowdown is coming, they
don’t care about getting more return for keeping their money tied up. They
just want to lock in yield. So, they pile into instruments with the best
yields, which are long-term fixed income instruments. That flight into
safe-haven assets pushes long-term bond prices up.
When prices go up, yields go down, and this causes a yield
curve inversion.
A yield curve inversion is considered a reliable recession
indicator on Wall Street for two reasons.
First,
it’s the bond market telling you something. Many people forget
this, but the bond market is actually
bigger than the stock market. The global capitalization of the stock
market is about $85 trillion. The global bond market measures in around $100
trillion. When $100 trillion is trying to tell you something, you should
listen.
A yield
curve inversion is that $100 trillion market telling you that a slowdown is
coming, and that it’s time to lock in yield wherever you can find it.
Second,
the yield curve has a history of getting it right. Since
1930, a yield curve inversion has successfully predicted every U.S.
recession. The timing hasn’t always been perfect (more on that later). But,
it has never failed to predict a major slowdown.
While yield curve inversions do tend to predict recessions,
they are also notoriously premature.
Both my research and research from LPL
Research show that yield curve inversions are actually a near-term
bullish, medium-term bearish sign for stocks.
Specifically, a full
yield curve inversion — typically defined by the 10-Year Treasury yield
falling below the 2-Year Treasury yield — has only happened a handful of
times over the past 50 years. Yes, each inversion successfully predicted
a recession. But, on average, the stock market didn’t peak until about 20
months after the inversion happened. During those 20 months, stocks tended to
post outstanding returns, with average returns north of 25%.
So, yield curves do
predict recessions, but they tend to be about 20 months early, and history
says you don’t want to sit out those 20 months.
Also of note, the big thing to watch is the 2-Year Treasury
yield. Immediately prior to each stock market peak in the past thirty years,
the yield curve actually normalized into the peak, driven by a plunge in the
2-Year Treasury yield on bond market expectations that rates were going to
get cut multiple times to help thwart a forthcoming slowdown.
The yield curve inversion is something to note. But, it’s
nothing to freak out about. Yet.
We are
only seven months from the 10-2 yield curve inversion in August 2019, and in
the middle of the February inversion. That doesn’t line up with how
these things work historically. You don’t get market peaks when everyone is
freaking out about a yield curve inversion. You get market peaks when
everyone forgets about the yield curve inversion, and animal spirits take
over. Normally, it takes about 20 months for that to happen. That timing pegs
the next market peak in the second quarter of 2021.
At the same time, the 2-Year yield is falling, but not
plunging like it has before prior recessions. Until that plunges on
expectations for huge rate cuts, there really isn’t much cause for concern
here.
In other words, the
yield curve is flashing warning signs right now — but no stop signs.
Fundamentally, I agree with the yield curve. The economy and
the market have some warning signs, such as the coronavirus outbreak and
slowing global growth. But, the core fundamentals remain pretty solid. Labor
markets are healthy. Spending conditions are favorable. Businesses are
growing. Central banks are injecting liquidity.
The fundamentals are still pretty good. So long as that
remains true, this bull market likely won’t die.
Yield curve inversions are scary. The February inversion is no
different. It’s scary.
But, it’s warning sign, not a stop sign. Be cognizant of the
building risks in financial and equity markets. But don’t ditch stocks. This
bull market isn’t over yet.
Luke Lango is a Markets
Analyst for InvestorPlace. He has been professionally analyzing stocks for
several years, previously working at various hedge funds and currently
running his own investment fund in San Diego. A Caltech graduate, Luke has
consistently been rated one of the world’s top stock pickers by TipRanks, and
has developed a reputation for leveraging his technology background to
identify growth stocks that deliver outstanding returns. Luke is also the
founder of Fantastic, a social discovery company backed by an LA-based
internet venture firm. As of this writing, Luke Lango did not hold a
position in any of the aforementioned securities.
Chapter 5 Diversification – Part
I Diversification
“Members of a
Yale class entering their prime giving years had decided to set up a private
fund, manage the money themselves, and give it to the University 25 years
later. The worrisome part for Yale was that it would have no control over the
fund, which was going to be invested in high-risk securities. What if all the
money was blown by these “amateurs"? And what if the scheme siphoned off
other potential donations?
Happily,
everything turned out for the best. Despite Yale’s initial efforts to
discourage the Class of 1954 from its plan, the class persisted. And last
October, its leaders announced that their original collective investment of
$380,000 had grown to $70 million, earning unalloyed gratitude from the
University and the right to name two new Science Hill buildings after their
class.” ----- What is your opinion? Apple is one of the stocks in their
portfolio. So shall you pick stocks individually or buy S&P500?
Shall you
diversify or not? Let’s compare AAPL with S&P500.
Stock returns from 1995-2015 - Apple and S&P
500
Regress
Apple’s Return on S&P500’s
Apple and
S&P500’s Stand Deviation Comparison
Questions for class discussion:
· Which one is better, the S&P500 or
Apple? In the past? About the future?
· Which one is riskier and which one’s
return is higher?
· Are you tempted to invest in APPLE or
SP500?
· How to find the next Apple?
· How much is the weight of Apple in
S&P500? For example, you have a total of $1,000 to invest in SP500, how
much you have invested in apple?
· How are the weights in the following
table calculated?
The table below shows the historical total market capitalization
of the 500 largest public U.S. companies. The current (12/31/2019) market value of the top 500 companies
is $28,125,589.1 million. The total value of the U.S. stock market as a
whole is $37,689,255.8 million.
U.S.
Top 500 Companies – Total Market Cap (USD, M)
Date |
Top 500 Total Market Value (USD, M) |
Total U.S. Stock Market Values (USD, M) |
12/31/2019 |
28,125,589.1 |
37,689,255.8 |
12/31/2018 |
22,065,655.2 |
30,102,771.2 |
12/31/2017 |
23,938,148.8 |
31,774,585.4 |
12/31/2016 |
20,222,191.7 |
27,362,567.7 |
12/31/2015 |
18,774,069.5 |
25,076,923.7 |
12/31/2014 |
19,331,041.0 |
26,338,838.9 |
12/31/2013 |
17,482,338.6 |
24,041,484.6 |
12/31/2012 |
13,499,871.5 |
18,673,959.2 |
12/31/2011 |
11,982,408.4 |
15,645,563.9 |
The S&P 500 component weights are listed from largest to
smallest. Data for each company in the list is updated after each trading
day. The S&P 500 index consists of most but not all of the largest
companies in the United States. The S&P market cap is 70 to 80% of the
total US stock market capitalization. It is a commonly used benchmark for
stock portfolio performance in America and abroad. Beating the performance of
the S&P with less risk is the goal of nearly every portfolio manager,
hedge fund and private investor.
# |
Company |
Symbol |
Weight |
Price |
Chg |
% Chg |
1 |
6.528728 |
115.37 |
2.21 |
(1.95%) |
||
2 |
5.592237 |
209.80 |
3.89 |
(1.89%) |
||
3 |
4.736621 |
3,199.00 |
99.04 |
(3.19%) |
||
4 |
2.231831 |
258.00 |
-0.66 |
(-0.26%) |
||
5 |
1.564675 |
1,461.00 |
9.98 |
(0.69%) |
||
6 |
1.531444 |
1,460.29 |
6.85 |
(0.47%) |
||
7 |
1.49574 |
213.29 |
3.03 |
(1.44%) |
||
8 |
1.381958 |
147.88 |
1.62 |
(1.11%) |
||
9 |
1.247373 |
140.70 |
1.09 |
(0.78%) |
||
10 |
1.217107 |
560.80 |
11.34 |
(2.06%) |
||
11 |
1.212866 |
202.47 |
2.02 |
(1.01%) |
||
12 |
1.072804 |
323.17 |
8.72 |
(2.77%) |
||
13 |
1.072536 |
99.73 |
1.71 |
(1.74%) |
||
14 |
1.069716 |
343.90 |
6.47 |
(1.92%) |
||
15 |
1.068046 |
282.79 |
6.32 |
(2.29%) |
||
16 |
0.8834 |
59.61 |
0.15 |
(0.25%) |
||
17 |
0.824925 |
494.00 |
15.02 |
(3.14%) |
||
18 |
0.817264 |
259.98 |
9.84 |
(3.93%) |
||
19 |
0.807395 |
194.86 |
3.20 |
(1.67%) |
||
20 |
0.800637 |
535.39 |
29.52 |
(5.84%) |
||
21 |
0.784601 |
122.91 |
1.98 |
(1.64%) |
||
22 |
0.783188 |
52.72 |
1.35 |
(2.63%) |
||
23 |
0.734436 |
28.80 |
0.09 |
(0.31%) |
||
24 |
0.7285 |
44.90 |
0.39 |
(0.86%) |
||
25 |
0.722793 |
80.04 |
0.41 |
(0.51%) |
Historical data about the component of
S&P500
Ticker |
Company Name |
6/30/2019 |
12/31/2018 |
12/31/2017 |
12/31/2016 |
12/31/2015 |
12/31/2014 |
MSFT |
Microsoft Corp. |
4.20% |
3.73% |
2.89% |
2.51% |
2.48% |
2.10% |
AAPL |
Apple Inc. |
3.54% |
3.38% |
3.81% |
3.21% |
3.28% |
3.55% |
AMZN |
Amazon.com Inc. |
3.20% |
2.93% |
2.05% |
1.54% |
1.45% |
0.65% |
FB |
Facebook Inc. |
1.90% |
1.50% |
1.85% |
1.40% |
1.33% |
0.72% |
BRK.B |
Berkshire Hathaway Inc |
1.69% |
1.89% |
1.67% |
1.61% |
1.38% |
1.51% |
JNJ |
Johnson & Johnson |
1.51% |
1.65% |
1.65% |
1.63% |
1.59% |
1.61% |
GOOG |
Alphabet Inc. Class C |
1.36% |
1.52% |
1.39% |
1.19% |
1.26% |
0.85% |
GOOGL |
Alphabet Inc. Class A |
1.33% |
1.49% |
1.38% |
1.22% |
1.27% |
0.84% |
XOM |
Exxon Mobil Corp. |
1.33% |
1.37% |
1.55% |
1.94% |
1.81% |
2.16% |
JPM |
JPMorgan Chase & Co. |
1.48% |
1.54% |
1.63% |
1.60% |
1.36% |
1.29% |
V |
Visa Inc. |
1.23% |
1.10% |
0.91% |
0.76% |
0.84% |
0.56% |
PG |
Procter & Gamble Co |
1.13% |
1.09% |
1.03% |
1.17% |
1.21% |
1.36% |
BAC |
Bank of America Corp. |
1.05% |
1.07% |
1.26% |
1.16% |
0.98% |
1.04% |
VZ |
Verizon Communications Inc |
0.97% |
1.11% |
0.95% |
1.13% |
1.05% |
1.07% |
INTC |
Intel Corp. |
0.88% |
1.02% |
0.95% |
0.89% |
0.91% |
0.95% |
CSCO |
Cisco Systems Inc |
0.96% |
0.93% |
0.83% |
0.79% |
0.77% |
0.78% |
UNH |
UnitedHealth Group Inc |
0.95% |
1.14% |
0.94% |
0.79% |
0.63% |
0.53% |
PFE |
Pfizer Inc. |
0.98% |
1.20% |
0.95% |
1.02% |
1.11% |
1.08% |
CVX |
Chevron Corp. |
0.97% |
0.99% |
1.04% |
1.15% |
0.95% |
1.17% |
T |
AT&T Inc. |
1.00% |
0.99% |
1.05% |
1.36% |
1.18% |
0.96% |
HD |
Home Depot Inc |
0.94% |
0.92% |
0.97% |
0.85% |
0.94% |
0.76% |
MRK |
Merck & Co Inc |
0.88% |
0.95% |
0.67% |
0.84% |
0.82% |
0.89% |
MA |
Mastercard Inc. |
0.97% |
0.82% |
0.62% |
0.51% |
0.54% |
0.45% |
BA |
Boeing Co. |
0.78% |
0.81% |
0.72% |
0.46% |
0.51% |
0.48% |
WFC |
Wells Fargo & Co |
0.78% |
0.93% |
1.18% |
1.29% |
1.41% |
1.43% |
http://siblisresearch.com/data/weights-sp-500-companies/
How to Calculate
the Weights of Stocks
The weights of your stocks can play a big role
in your investment strategy. Here's how to calculate them.
Calculating the weights of stocks you own can be
useful to your investment strategy. For example, if your investment goal is
to allocate no more than 15% of your portfolio to any single stock,
determining the weights of the stocks in your portfolio can tell you whether
or not you need to make any changes. Here's how to calculate the weights of
stocks, what this information means to you, and an example of how you can use
this.
Calculating the
weights of stocks
Basically, to determine the weights of each of your stocks, you'll
need two pieces of information. First, you'll need the cash values of each of
the individual stocks you want to find the weight of.
You'll also need your total portfolio value. If
you want to determine the weights of your stock portfolio, simply add up the
cash value of all of your stock positions. If you want to calculate the
weights of your stocks as a portion of your entire portfolio, take your
entire account's value – including stocks, bonds, cash, and any other
investments.
The calculation is simple enough. Simply divide
each of your stock position's cash value by your total portfolio value, and
then multiply by 100 to convert to a percentage.
What the weights
tell you
These weights tell you how dependent your portfolio's
performance is on each of your individual stocks. For example, your
portfolio's day-to-day fluctuations will depend much more on a stock that
makes up 20% of the total than one that only makes up 5%.
So, when your
heavily weighted stocks do well, your portfolio can go up quickly. For
example, if a stock with a 20% weight in a $50,000 portfolio doubles, it
would mean a $10,000 gain. On the other hand, if a stock only makes up 2% of
your portfolio, your gain would only be $1,000, even though the stock itself
was a home run.
Conversely,
heavily weighted stocks can drag your portfolio down during tough times,
while lower-weighted stocks will have a smaller effect.
Examining your
portfolio: An example
Let's say that you own the following stock investments: $2,000
of Microsoft, $3,000 of Wal-Mart, $2,500 of Wells
Fargo, and $4,000 of Johnson & Johnson. A quick
calculation shows that your total portfolio value is $11,500, and using the
formula mentioned earlier, you can calculate the weights of each of your four
stocks:
Stock |
Cash Value |
Weight |
Microsoft |
$2,000 |
17.4% |
Wal-Mart |
$3,000 |
26.1% |
Wells Fargo |
$2,500 |
21.7% |
Johnson & Johnson |
$4,000 |
34.8% |
In this example, Johnson & Johnson carries
twice the weight of Microsoft; therefore, a big move in J&J will have
double the effect on your overall portfolio than the same move in Microsoft
would.
There are a lot more losing than winning
stocks in the S&P 500, Jim Cramer says
PUBLISHED THU,
AUG 20 20206:28 PM EDTUPDATED THU, AUG 20 20206:30 PM EDT
KEY POINTS
https://www.cnbc.com/2020/08/20/jim-cramer-the-sp-500-has-a-lot-more-losers-than-winning-stocks.html
(video)
·
“When you get down
into the weeds of this market, what you see is that there are a lot more
losers than there are winners,” CNBC’s Jim Cramer said.
·
“That’s the nature
of the Covid economy, and now that there’s no one in Washington willing to
play gardener, maybe it’s only a matter of time before the weeds overrun the
entire patch,” the “Mad Money” host said.
·
“We have a bizarre
situation where some companies are doing very well,” Cramer said, “but a lot
of other companies are getting crushed.”
The stock
market does not appear as strong as the headline numbers in the benchmark
index may portray after taking a look at the performances of its components,
CNBC’s Jim Cramer said
Thursday.
While the big tech
stocks have made significant gains that carried the S&P 500 back to record
levels, most of the stocks in the broad average are down this year, he said.
“When you get
down into the weeds of this market, what you see is that there are a lot more
losers than there are winners,” said the “Mad Money” host, likening the stock market to a patch of grass.
“That’s the nature of the Covid economy, and now that there’s no one in
Washington willing to play gardener, maybe it’s only a matter of time before
the weeds overrun the entire patch.”
The major averages
climbed in Thursday’s session, despite the negative news of 1.1 million new
unemployment claims that were filed in the week ended Aug. 15. More than 1
million people applied for weekly jobless benefits in 22 of the last 23 weeks
amid a global coronavirus pandemic.
The Dow Jones climbed almost 47 points for a 0.1% gain,
breaking a three-day losing streak, to close at 27,739.73. The S&P 500 rose 0.3% to 3,385.51, a
handful of points shy of its record close Tuesday, and the Nasdaq Composite rallied 1% to 11,264.95 for
a new closing record.
“We have a
bizarre situation where some companies are doing very well,” Cramer said,
“but a lot of other companies are getting crushed.”
Big Tech names
are all up double digits this year with Amazon and Apple, which boasts a $2 trillion valuation, both surging
78% and 61%, respectively, year to date. Nvidia, DexCom, West Pharmaceutical Services, PayPal and Abiomed are the top five S&P
gainers this year with advances of more than 80%, according to FactSet.
On the losing
side are the cruise ships, oil companies, pipelines, retailers, airlines and
banks, among others, Cramer pointed out. Norwegian Cruise Line and Carnival, whose stocks are down more
than 70% this year, have lost the most value on the benchmark. Occidental Petroleum, Coty and TechnipFMC round out the bottom
five, all down 60% or more, based on FactSet data.
Kohl’s is the biggest decliner
in retail, dropping 63% from the beginning of the year. The company has lost
nearly 19% in value this week alone.
The S&P 500
is now up 4.79% year to date.
Covid-19, which
has infected at least 5.56 million Americans and been connected to nearly
174,000 deaths in the country, according to data compiled by Johns Hopkins
University, and the economic lockdowns implemented to slow the spread have
dealt the hardest hand to small businesses. In order to stay afloat in a
physically distant and remote world, businesses have had to pivot to the web
to connect with consumers.
Most small
retailers can’t pivot online fast enough, and many of them will go under
without fiscal support from the government, Cramer said.
The S&P
500, however, continues to go higher, thanks to about 40% of the stocks that
make up the index, he added.
“That’s pretty
incredible, and the lack of breadth here explains a lot more about how the
real economy’s doing,” Cramer said, referring back to the grass analogy. “The
truth is the weeds are more representative than the healthy patches of lawn,
and, in many ways, it’s getting worse, not better, as the weeds begin, I think,
to infect the nice part.”
For
discussion:
·
Do YOU AGREE with Jim
Cramer?
·
So Jim Cramer recommend
S&P 500 to his followers? Do you agree with him?
·
HW chapter 5 -1 (Due
with the second mid-term exam)
1
Calculate the monthly stock return and risk of Apple and
SP500 in the past five years. And draw a conclusion regarding the tradeoff
between risk and return.
Steps:
From
finance.yahoo.com, collect stock prices of the above firms, in the past five
years
Steps:
· Goto finance.yahoo.com,
search for the companies (Apple and S&P500, repectively)
· Click
on “Historical prices” in the left column on the top and choose monthly stock
prices.
· Change
the starting date and ending date to “Oct 8th, 2015” and “Oct 8th,
2020”, respectively.
· Download
it to Excel
· Delete
all inputs, except “adj close” – this is the closing price adjusted for
dividend.
Evaluate
the performance of each stock:
· Calculate
the monthly stock returns.
· Calculate
the average return
· Calculate
standard deviation as a proxy for risk
Please use the following excel file
as reference.
2. Calculate the most recent weight of Apple in SP500. Also
calculate the weight of GOOGLE, Amazon, Netflix.
Hint: please use $28,125,589.1 millionfor SP500 value. The website for this information is
here: http://siblisresearch.com/data/total-market-cap-sp-500.
4.
Compare the above
top 10 best and worst stocks and give it a try to summarizes about
the similarities among stocks in each group, such as location, industry
sector, etc. if you can find any.
What Apple’s Stock Split
Means for You
· By STEVEN RUSSOLILLO
WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has now split its stock
four times throughout its history. It previously conducted 2-for-1 splits on
three separate occasions: February 2005, June 2000 and June 1987. According
to some back-of-the-envelop math by S&P’s Howard Silverblatt,
if Apple never split its stock, you’d have eight shares for each original one
prior to the most recent split. So Friday’s $645.57 closing level would
translate to $5164.56 unadjusted for splits.
No Here are five things you need to know
about Apple’s stock split.
WHO DOES THE STOCK SPLIT IMPACT? Investors who
owned Apple shares as of June 2 qualify for the stock split, meaning they get
six additional shares for every share held. So if an investor held one Apple
share, that person would now hold a total of seven shares. Apple also
previously paid a dividend of $3.29, which now translates into a new
quarterly dividend of $0.47 per share.
WHY IS APPLE DOING THIS?
The iPhone and iPad maker says it is trying to attract a
wider audience. “We’re taking this action to make Apple stock more accessible
to a larger number of investors,” Apple CEO Tim Cook said in
April. But the comment also marked an about-face from two years earlier. At
Apple’s shareholder meeting in February 2012, Mr. Cook said he didn’t see the
point of splitting his company’s stock, noting such a move does “nothing” for
shareholders.
WILL APPLE GET ADDED TO THE DOW? It’s unclear
at the moment, although a smaller stock price certainly makes Apple a more
attractive candidate to get added to blue-chip Dow. Apple, the bigge, your
screens aren’t lying to you. Shares of Apple Inc. now trade under $100, a
development that hasn’t happened in years.
Apple’s unorthodox 7-for-1 stock split,
announced at the end of April, has finally arrived. The stock started trading
on a split-adjusted basis Monday morning, and recently rose 1% to $93.14.
In a stock split, a company increases the
number of shares outstanding while lowering the price accordingly. Splits
don’t change anything fundamentally about a company or its valuation, but
they tend to make a company’s stock more attractive to mom-and-pop investors.
Apple shares rallied 23% from late April, when the company announced the
split in conjunction with a strong quarterly report, through Friday.
A poll conducted by our colleagues
at MarketWatch found 50% of respondents said they would buy Apple
shares after the split. Some 31% said they already owned the stock and 19%
said they wouldn’t buy it. The survey received more than 20,000 responses.
st U.S. company by market capitalization,
has never been part of the historic 30-stock index, a factor that many
observers attributed to its high stock price. The Dow is a price-weighted
measure, meaning the bigger the stock price, the larger the sway for a
particular component. That is different from indexes such as the S&P 500,
which are weighted by market caps (each company’s stock price multiplied by
shares outstanding).
WILL APPLE KEEP RALLYING? Since the financial
crisis, companies that have split their stocks have struggled in the short
term and outperformed the broad market over a longer time horizon. Since
2010, 57 companies in the S&P 500 have split their shares. Those stocks
have averaged a 0.2% gain the day they started trading on a split-adjusted
basis, according to New York research firm Strategas Research
Partners. A month later, they have risen just 0.5%. But longer term, the
average gains are more pronounced. Since 2010, these stocks have averaged a
5.4% increase three months after a split and a 28% surge one year
later, Strategas says.
WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has
now split its stock four times throughout its history. It previously
conducted 2-for-1 splits on three separate occasions: February 2005, June
2000 and June 1987. According to some back-of-the-envelop math by
S&P’s Howard Silverblatt, if Apple never split its stock, you’d have
eight shares for each original one prior to the most recent split. So
Friday’s $645.57 closing level would translate to $5164.56 unadjusted for
splits.
For class discussion:
Why Apple needs to do so? Is that necessary? Why Google does not
follow Apple and make its stock price cheaper and affordable?
Tesla jumps 12% as
stock split takes effect, Apple gains 3%
PUBLISHED MON,
AUG 31 202011:20 AM EDTUPDATED MON, AUG 31 20204:26 PM EDT
KEY POINTS
·
Monday’s gains are
just the latest in a string of strong performances since the companies
announced plans for stock splits.
·
Apple said July 30
its board approved a 4-for-1 stock split. Since then, the stock is up more
than 32%.
·
Tesla has
skyrocketed more than 70% since it announced a 5-for-1 stock split on Aug.
11.
Shares of Apple and Tesla rose sharply Monday, the
first day of their stock splits.
Apple advanced
3.4% and was the best-performing component in the Dow Jones Industrial
Average. Tesla jumped 12.6%.
Monday’s gains
were the latest in a string of strong performances since the companies
announced the stock splits.
Apple
said July 30 its board approved a
4-for-1 stock split. Since then, the stock is up more than 34%. Tesla has
skyrocketed more than 80% since it announced a 5-for-1 stock split on Aug. 11.
Billionaire
investor Leon Cooperman, however, said Monday that run-ups on the back of stock-split announcements are a
troublesome sign for the market.
“Look at Tesla
and Apple: Everybody understands that splits don’t create value,” the founder
of Omega Advisors told CNBC’s “Squawk Box.” “My dad once
told me if you gave me five singles for a $5 bill, I’m no better off.”
Monday’s gains
in Apple and Tesla came amid high volume as smaller traders are able to snap
up shares in both companies at a much lower price than on Friday.
Apple traded
223.4 million shares, which is roughly 25% more than the stock’s 30-day
volume average of 178.588 million. Tesla shares exchanged hands 115.6 million
times, well above its 30-day volume average of 73.369 million.
This year,
smaller traders have been more actively participating in the market as
commission-free online brokerage Robinhood grows in popularity. But Cooperman
sees this as a potential sign of being overheated.
“I see signs of
euphoria creeping into the market: the IPO SPAC market is one, [and] the
craziness in many of the stocks that the Robinhood crowd has latched onto,”
Cooperman said. “You see a Kodak go from $1.50 to $60 and from $60 to $6 in a
very short period of time … and when you look into it, it’s the Robinhood
crowd taking it up.”
By
Chapter 5 Part II – Mutual Funds and ETF
Want to improve your personal
finances? Start by taking this quiz to get an idea of your investment risk
tolerance – one of the fundamental issues to consider when planning your
investment strategy, either alone or in consultation with
a financial services professional.
Investment Risk Tolerance Quiz (take it and access
your risk tolerance in investing)
https://njaes.rutgers.edu/money/assessment-tools/investment-risk-tolerance-quiz.pdf
Your risk tolerance (the degree of
uncertainty you are willing to take on to achieve potentially greater
rewards) is determined by a combination of factors, including your investment goals and
experience, how much time you have to invest, your other
financial resources and your “fear
factor.”
Investments at the top of the pyramid tend to be
speculative and some also are illiquid (meaning they are harder to quickly
convert into cash without loss of value). While they offer more potential
reward, they also carry greater risks for loss of principal than investments
at the base of the pyramid.
Less risky investments at the bottom of the pyramid are
more liquid and offer stable (although lower) rates of return.
Discussion: Based on your risk tolerant score, which of the above
shall you choose? Why?
Example: Optimally
diversified portfolio
1.
3.
For class discussion:
1. What
is value stock? Example?
2. What
is small cap value? Example?
3. What
is large value? Example?
4. Shall
we consider bond for diversification purpose?
5. Shall
we include international stocks to establish a diversified portfolio?
6. What
benefits can be gained from diversification with bond and international
stocks?
Mutual fund vs. ETF
What
is ETF? (Video)
Mutual Funds vs. ETFs - Which Is Right
for You? (Video)
For discussion:
What one of the above funds
is the most favorite one to you? Why?
1.
How to tell the risk
level based on standard deviation shown in step 1?
2.
What is the difference
between rewarded risk and unrewarded risk? Example?
3.
Write down the CAPM
model.
4.
Among the four models shown
in step 3, which one is the best?
For class discussion:
What is ETF?
What is the pro
and cons to invest in ETF?
Examples of ETF?
Examples of ETF: Powershares (QQQ) – NASDAQ 100 Index (Large-cap
growth stocks)
For class discussion:
When we compare QQQ with S&P500, which one is better
in terms of performance in the past ten years?
Which one is riskier? Why?
QQQ |
This ETF offers exposure to one of the
world's most widely-followed equity benchmarks, the NASDAQ, and has become one
of the most popular exchange-traded products. The significant average daily
trading volumes reflect that QQQ is widely used as a trading vehicle, and
less as a components of a... |
SPY |
SPY is one of the largest and most
heavily-traded ETFs in the world, offering exposure to one of the most well
known equity benchmarks. While SPY certainly may have appeal to investors
seeking to build a long-term portfolio and include large cap U.S. stocks,
this fund has become extremely popular... |
The
table below compares many ETF metrics between QQQ and SPY. Compare fees,
performance, dividend yield, holdings, technical indicators, and many other
metrics to make a better investment decision.
https://etfdb.com/tool/etf-comparison/QQQ-SPY/#performance
QQQ
SPY
|
4.16% |
3.90% |
2 Week Return |
5.21% |
5.51% |
4 Week Return |
5.80% |
4.24% |
13 Week Return |
8.39% |
9.65% |
26 Week Return |
42.70% |
25.73% |
YTD Return |
35.10% |
9.31% |
1 Year Return |
52.56% |
20.57% |
3 Year Return |
98.19% |
44.34% |
Beta |
1.05 |
1.0 |
P/E Ratio |
30.85 |
24.17 |
Annual Dividend Rate |
$1.63 |
$5.68 |
Dividend Date |
2020-09-21 |
2020-09-18 |
Dividend |
$0.39 |
$1.34 |
Annual Dividend Yield % |
0.58% |
1.65% |
5 Day Volatility |
236.98% |
248.89% |
20 Day Volatility |
26.87% |
18.89% |
50 Day Volatility |
28.13% |
18.33% |
200 Day Volatility |
25.46% |
19.94% |
Standard Deviation |
31.42% |
25.34% |
Discussion: How
to tell the performance of a fund? Return only? The higher the better? Or
alpha?
Alpha, often considered the active return on an investment,
gauges the performance of an investment against a market index used as a
benchmark, since they are often considered to represent the
market’s movement as a whole. The excess returns of
a fund relative to the return of a benchmark index is the
fund's alpha.
Alpha is most often used for mutual funds and other similar
investment types. It is often represented as a single number (like 3 or -5),
but this refers to a percentage measuring how the portfolio or fund
performed compared to the benchmark index (i.e. 3% better or 5% worse).
Alpha is often used with beta, which measures volatility or
risk, and is also often referred to as “excess return” or “abnormal rate of
return”. (Investorpedia)
HW chapter 5 -2 (Due with the second mid-term exam)
·
Work on this investment risk tolerance
test and report your score. Make a self-evaluation about yourself in
terms of your risk tolerance level.
·
Based on your risk level, set up an investment plan.
Please provide a rationale.
·
Compare QQQ with SPY. Which one of the two is more
suitable to you? Please provide a
rationale.
·
What is alpha?
The
big mistake mutual-fund investors make
Published: Apr 21, 2017 4:04 a.m. ET
11By PAULA. MERRIMAN
You have probably heard
about what's known as the DALBAR effect.
It's the fact that, as a group,
mutual-fund investors underperform the funds in which they invest.
Quick background: The reason
for this effect, amply documented over nearly a quarter-century by a Boston
research firm, is investors' behavior.
In short, mutual fund shareholders tend to buy and sell based
on their emotional reactions to bull markets and bear markets, real or
expected. Their timing is usually wrong, and in the end they would have done
better by buying and holding.
OK, here's the bad news: If
you're average, chances are you will underperform the funds that you own.
But here's the good news:
I've discovered a group of investors who are apparently doing just the
opposite: They are outperforming the funds they own.
To understand how that's
possible, you'll need to bear with me as I walk through some steps. For your
patience, you will be rewarded at the end with my suggestion for how you too
may be able to perform what seems to be a minor financial miracle.
I first discovered this anomaly
while I was comparing target-date retirement funds offered by Fidelity and
Vanguard.
What I found is more than
just coincidence: It appears in the latest 10-year performance results in
four pairs of retirement funds — those with target dates of 2020, 2030, 2040
and 2050.
Let's take the Vanguard and
Fidelity 2020 funds as examples. The numbers are clear on two points.
· The
Vanguard fund has higher returns.
· While
investors in the Fidelity fund (consistent with the DALBAR effect noted
above), achieved lower returns than those of the fund itself, investors in
Vanguard's 2020 fund achieved higher results than the fund.
Here are the numbers:
For the 10 years ended March
31, 2017, the Fidelity 2020 Freedom Fund FFFDX compounded at
4.47%, while investor returns (provided by Morningstar Inc.) were only 3.13%.
The Vanguard Target Retirement 2020 Fund VTWNX compounded at 5.23%, and
investor returns were 6.53%.
How is it possible to have
such a large additional return?
The Vanguard fund return is
based on the assumption of a lump-sum initial investment made at the end of
March 2007 with no further additions or withdrawals other than reinvestment
of dividends.
The investor return tracks
the dollars that investors as a group actually invested, and when they
invested them. (I'll come back to that point in a moment.)
Here are the comparable
results for three other pairs of target-date funds.
2030: Fidelity FFFEX
grew at 4.66%; investor returns were only 3.53%. Vanguard
VTHRX grew at 5.31%; investor returns were 7.58%.
2040: Fidelity FFFFX
grew at 4.78%; investor returns were only 4.17%. Vanguard VFORX, -0.40%
grew at 5.69%; investor returns were 8.49%.
2050: Fidelity FFFHX, -0.41%
grew at 4.61%; investor returns were 6.92%. (No, that's not a typo; stay
tuned.) Vanguard VFIFX, -0.39%
grew at 5.71%; investor returns were 8.70%.
In every case, the Vanguard
funds achieved higher performance. That's not hard to explain: Fidelity's funds
charge higher expenses, hold more cash, use active management and have much
higher turnover.
But those things don't
explain how investors in five of these eight funds did the seemingly
impossible: outperformed the funds in which they invested.
I think the answer is to be
found in investor behavior.
Target-date fund
shareholders are typically setting money aside methodically for their
eventual retirement through regular withdrawals from their paychecks.
You probably know the name
for this practice: dollar-cost averaging (DCA), investing the same amount
every month or every pay period.
DCA lets investors take
advantage of the rise and fall of stock prices by automatically buying more
shares when prices are low and fewer shares when prices are high. The result:
The average price paid per share is lower than the average of all the prices
at which those shares were bought.
I think this explains the
higher investor returns in five of these eight funds.
Two questions remain:
· Why
did Vanguard investors outperform while those in three of the four Fidelity
funds lagged?
· Why
did investors in Fidelity's 2050 fund do better than
investors in the other three Fidelity funds under study?
Though I can't back up my
answers with numbers, I'll take a stab at answering these questions. Both
answers, I believe, come down once again to investors' collective behavior.
To answer the first
question, I think Vanguard simply attracts a different sort of investor than
Fidelity.
· Vanguard marketing emphasizes the firm's
low costs, its index funds, the higher quality of its stocks and bonds and
its buy-and-hold culture. Vanguard urges investors to accept the returns of
the market.
· Fidelity's
marketing focuses on active managers who pick stocks, backed up by impressive
stock analysts. Fidelity urges investors to seek higher performance.
OK, but so why did investors
in Fidelity's 2050 fund outperform the fund itself, while those in the 2020,
2030 and 2040 funds underperformed?
Here I have to speculate.
I'm guessing that investors with an eye on a 2050-ish retirement are younger
and often have less money with which they want to try to beat the odds.
For this reason, I suspect
that such investors are less likely to try to second-guess the market's ups
and downs and more likely to simply trust their funds.
I promised a suggestion for
how you might be able to outperform a fund you're invested in.
My best suggestion is to use dollar-cost averaging. This will
keep your average cost-per-share down. And it will keep you investing
regularly. Both are extremely good habits.
However, at the risk of
throwing cold water on a good idea, I have to point out that DCA makes a positive
difference only over extended periods, and only during periods when the
market ends up higher than it started. (The reason for this is simple: Even
if you buy at below-average prices, if your investment loses money over the
long run, it loses money. Sorry about that.)
The latest 10-year period
(like most 10-year periods) was a positive one for stock investors. The most
recent eight years were especially strong, with the S&P 500 index SPX, -0.47% appreciating
by more than 300% (including reinvestment of dividends).
Although things won't always
be that good, the market historically goes up about two-thirds of the time
and down only one-third.
So if you take a long-term
perspective, keep your expectations realistic and adopt excellent investing
habits, I think there's a good chance you, like many of Vanguard's
target-date investors, will be able to do the seemingly impossible.
For discussion:
What is suggested by the
author? Do you agree?
Investors pulled $3.5 billion out of the biggest tech
ETF in a single day — the most since 2000
Sep. 21, 2020, 06:36 PM
Investors on Friday pulled
$3.5 billion out of the popular Invesco
QQQ Trust Series 1 ETF, which tracks the Nasdaq
100 index, according to Bloomberg data.
That marked the biggest
single-day outflow since October 2000, amid the dot-com bubble.
The mass exit reflects the unease in the tech sector that's
sent the Nasdaq 100 tumbling into correction territory in recent weeks. On
Monday, the gauge sat roughly 13% below its September 2 peak.
The Invesco QQQ ETF, the biggest technology exchange-traded
fund available to investors, had more than $120 billion in assets as of
Friday.
The three-week skid in technology stocks comes as investors
grapple with uncertainty surrounding
the November presidential election, additional fiscal stimulus measures in
response to the COVID-19 pandemic, and the development and rollout of a
COVID-19 vaccine.
The Nasdaq 100 is on
pace to lose more than 10% in September, which would be its worst month since
2008.
On Monday, despite continued selling in the index, the Nasdaq
100 outperformed the Dow Jones industrial average and the S&P 500,
suggesting that investors may warm up to tech stocks again as economic
uncertainty persists.
Chapter 8 Stock Market
Part I: Stock
Market Popular Websites
Stock screening tools
Reuters stock screener to help select stocks
http://stockscreener.us.reuters.com/Stock/US/
FINVIZ.com
http://finviz.com/screener.ashx
WSJ stock screen
http://online.wsj.com/public/quotes/stock_screener.html
Simply the Web's Best
Financial Charts
How to pick stocks
Capital Asset Pricing Model (CAPM)Explained
https://www.youtube.com/watch?v=JApBhv3VLTo
Fama French 3 Factor Model Explained
https://www.youtube.com/watch?v=zWrO3snZjuA
Ranking stocks using PEG ratio
https://www.youtube.com/watch?v=bekW_hTehNU
Class discussion topics and homework
(Are the following statements right or wrong? Why?, due with the second
mid-term exam)
1: My investment in company A is a sure thing.
2: I would never buy stocks now because the
market is doing terribly.
3: I just hired a great new broker, and I am
sure to beat the market.
4: My investments are well diversified
because I own a mutual fund that tracks the S&P 500.
5: I made $1,000 in the stock market today.
6: GM’s
earning report is better than expected. But GM stock price went down instead
of going up after the earning news was released. How come?
7: Paypal’s price has gone up so much in the past
several months. I should invest in Paypal now.
Part II: Behavior
Finance
Behavior
Finance Introduction PPT
Vanguard
Behavior Finance Lecture PPT - FYI
Behavior
Finance Class Notes - FYI
Behavioral Finance https://www.investopedia.com/terms/b/behavioralfinance.asp
By WILL KENTON Reviewed By ERIC ESTEVEZ Updated Jul 28, 2020
What Is Behavioral Finance?
Behavioral finance, a sub-field of
behavioral economics, proposes that psychological influences and biases
affect the financial behaviors of investors and financial practitioners.
Moreover, influences and biases can be the source for explanation of all types
of market anomalies and specifically market anomalies in the stock market,
such as severe rises or falls in stock price.
Understanding Behavioral Finance
Behavioral finance can be analyzed from a
variety of perspectives. Stock market returns are one area of finance where
psychological behaviors are often assumed to influence market outcomes and
returns but there are also many different angles for observation. The purpose
of classification of behavioral finance is to help understand why people make
certain financial choices and how those choices can affect markets. Within
behavioral finance, it is assumed that financial participants are not
perfectly rational and self-controlled but rather psychologically influential
with somewhat normal and self-controlling tendencies.
One of the key aspects of behavioral finance
studies is the influence of biases. Biases can occur for a variety of
reasons. Biases can usually be classified into one of five key concepts. Understanding
and classifying different types of behavioral finance biases can be very
important when narrowing in on the study or analysis of industry or sector
outcomes and results.
KEY TAKEAWAYS
Behavioral Finance Concepts
Behavioral finance typically encompasses
five main concepts:
Biases Studied in Behavioral Finance
Breaking down biases further, many
individual biases and tendencies have been identified for behavioral finance
analysis, including:
Disposition Bias
Disposition bias refers to when investors
sell their winners and hang onto their losers. Investors' thinking is that
they want to realize gains quickly. However, when an investment is losing
money, they'll hold onto it because they want to get back to even or their
initial price. Investors tend to admit they are correct about an investment
quickly (when there's a gain). However, investors are reluctant to admit when
they made an investment mistake (when there's a loss). The flaw in
disposition bias is that the performance of the investment is often tied to
the entry price for the investor. In other words, investors gauge the
performance of their investment based on their individual entry price
disregarding fundamentals or attributes of the investment that may have
changed.
Confirmation Bias
Confirmation bias is when investors have a bias toward
accepting information that confirms their already-held belief in an
investment. If information surfaces, investors accept it readily to confirm
that they're correct about their investment decision—even if the information
is flawed.
Experiential Bias
An experiential bias occurs when investors'
memory of recent events makes them biased or leads them to believe that the
event is far more likely to occur again. For example, the financial crisis in
2008 and 2009 led many investors to exit the stock market. Many had a dismal
view of the markets and likely expected more economic hardship in the coming
years. The experience of having gone through such a negative event increased
their bias or likelihood that the event could reoccur. In reality, the
economy recovered, and the market bounced back in the years to follow.
Loss Aversion
Loss aversion occurs when investors place a
greater weighting on the concern for losses than the pleasure from market
gains. In other words, they're far more likely to try to assign a higher
priority on avoiding losses than making investment gains. As a result, some
investors might want a higher payout to compensate for losses. If the high
payout isn't likely, they might try to avoid losses altogether even if the
investment's risk is acceptable from a rational standpoint.
Familiarity Bias
The familiarity bias is when investors tend
to invest in what they know, such as domestic companies or locally owned
investments. As a result, investors are not diversified across multiple
sectors and types of investments, which can reduce risk. Investors tend to go
with investments that they have a history with or have familiarity.
Behavioral Finance in the Stock Market
The efficient market hypothesis (EMH) says that at any given time in a
highly liquid market, stock prices are efficiently valued to reflect
all the available information. However, many studies have documented
long-term historical phenomena in securities markets that contradict the
efficient market hypothesis and cannot be captured plausibly in models based
on perfect investor rationality.
The EMH is generally based on the belief
that market participants view stock prices rationally based on all current
and future intrinsic and external factors. When studying the stock market,
behavioral finance takes the view that markets are not fully efficient. This
allows for observation of how psychological factors can influence the buying
and selling of stocks.
The understanding and usage of behavioral
finance biases is applied to stock and other trading market movements on a
daily basis. Broadly, behavioral finance theories have also been used to
provide clearer explanations of substantial market anomalies like bubbles and
deep recessions. While not a part of EMH, investors and portfolio managers
have a vested interest in understanding behavioral finance trends.
These trends can be used to help analyze market price levels and fluctuations
for speculation as well as decision-making purposes.
Examples:
Homework: (due with the second mid-term
exam)
·
Among the 7 biases explained in the above videos, pick
three biases that have the biggest impact on you, and explain what they are
using examples.
·
What is behavior finance? Why is it important?
Value,
Growth At Reasonable Price, portfolio strategy, ETF investing
https://seekingalpha.com/article/4087813-how-to-use-behavioral-finance-to-make-money
Summary
The topic of this article is to use some of the behavioral
biases of investors to generate alpha.
In the first section of this article, we’ll
discuss how to take advantage of “loss aversion”.
In the first section of this article, we’ll
discuss how to take advantage of “temporal discounting”.
Haven't we heard enough about
how typical investor is not fully rational and does not really epitomize
"economic man"?! In their 1979 paper published in Econometrica,
Kahneman and Tversky found the median coefficient of loss aversion to be
about 2.25, i.e., losses bite about 2.25 times more than equivalent gains.
But, understanding the theory, various biases, and why those might exist and
persist is only useful if you have an intellectual curiosity about the topic
of behavioral finance. What about using this knowledge to generate alpha over
the long-term?
Leverage "loss aversion" to generate alpha
Fortunately, the desire to
come up with practical applications for investors has sparked quite a bit of
research. Namely, in the research conducted by Goldman Sachs team, they found
that 5% OTM calls historically exhibited 69% win rate, while 5% OTM short puts
92% win rate. What's the takeaway:
1.
Long call and short put positions offer a pretty good win rates
2.
Option traders clearly exhibit loss aversion, which is clear
from higher win rate offered by short puts vs. long calls. Fear is more
potent emotion than greed.
Of course, win rate does not
equate to alpha, as you might be losing a lot when trade is in a loss
position and make a little during "win" cases. Additionally, one
can argue that option win rates mentioned above correspond to typical market
gyrations; i.e. market tends to be in an up-cycle longer than in a
down-cycle. The Bulls climb up the stairs and the Bears fall out the window.
You would think that market
would price options in a way that would ensure no arbitrage. This might be
the case. Others might argue that going long calls is similar to leveraged
stock investing, i.e. multiple exposures to beta. So, by going long you have
good win rate and likely handsome payoff thanks to levered beta exposure.
Going short, on another hand, is similar to selling an insurance policy. This
works most of the time (seems around 92% of a time), but when it doesn't it
can wipe your entire position out. Remember AIG (NYSE:AIG) in
2008 (that was short CDS position… but short put options have very similar
payoff characteristics)?
In other words, I'm not
recommending going long calls an shorting puts. You would think that market
should get to no-arbitrage pricing at some point. Additionally, this strategy
would not be suitable for many. However, if you know how to manage
"wipe-out" risk, you might be willing to leverage others' loss
aversion to your advantage.
An example of how to use "win" rate in practice
(remember, "win" rate is not equivalent to rate of return)
Thanks to comments from the
readers of this article (particularly, thanks to Silent
Trader), I realized that it is not sufficient to limit the
discussion to "win" rate. Instead, I should highlight how
"win" rates could be leveraged by traders to generate profit. At
the end of the day, you will not be a winner if you win $1 in 69% of a time
and lose $10 in 31% of a time. Expected outcome of such bet is negative. So,
how one can fix this issue and still take advantage of "win" rates.
traders can utilize the knowledge
about "win" rates to devise a strategy involving loss-limit rules
that would allow them to take advantage most (if not all) of the upside while
limiting downsize to a particular level.
Given that "win"
rate is in their favor, they should be able to generate handsome returns
through limiting downside. Why do I think this should work? Because
Martingale System works even for roulette (where "win" rate is
lower than 50%) and in this case, one needs to figure out how to equalize
payoff and loss amounts in case of "win" and "lose".
So, how one can fix this issue
and still take advantage of "win" rates. You just need to find a
way to have dollar impact of "win" and dollar impact of "loss"
scenarios equal to each other. One needs to figure out how to equalize payoff
and loss amounts in case of "win" and "lose".
For instance, if investor made
40% return when long call position work out ("win"), she might set
40% drawdown limit when she rolls the position. Loss-limit rule is likely to
increase her chance of "loss", i.e. she might be stopped over more
often. However, you might run historical backtest to find a point where
"win" rate would still be higher than 50%. Even then there are
cases when market liquidity dries up and one might not have actual quotes. In
this case, neither stop losses or similar tools would help.
Furthermore, one can argue
that market's propensity for over-reacting to fear is already priced into the
pricing of put options. Therefore, observation of "win" rates could
be nothing but a reflection of asymmetry of payoffs.
Leverage "temporal discounting" to generate alpha
Temporal discounting is the tendency of people to discount
rewards as they approach a temporal horizon. To put it another way, it is a tendency to give greater value
to rewards as they move away from their temporal horizons and towards the
"now". For instance, a nicotine deprived smoker
may highly value a cigarette available any time in the next 6 hours but
assign little or no value to a cigarette available in 6 months.
Applying temporal discounting
to option pricing, one might realize that supply-demand dynamics might lead
to relatively cheap, longer dated maturities. One might argue that people
would not be trapped in temporal discounting when it comes to option pricing.
Don't we all use IV's calculated using Black-Scholes? Yes, we do. However,
don't forget that our models assume that volatility increases with the square
root of time and that IV levels are driven by actual demand (and supply)
dynamics.
Trending markets and the fact
that momentum factor worked its magic, one can clearly see that volatility
does not increase with the square root of time in practice. Hence, volatility
is typically underpriced for longer dated options. This makes LEAPs a
somewhat cheap instrument over the long-term (you might be interested
in Jamie Mai's points covered on this topic). Of course, there will be
times when IV jumps due to market fear, however over the long term, human
nature (temporal discounting) is likely to keep the price of LEAPs cheaper
than they should be.
Conclusion
Investors might be able to take advantage of market's "loss
aversion" by rolling long call and short put positions. However, this
approach comes at the expense of "wipe-out" risk. Keep the AIG 2008
experience in mind!
Temporal discounting is another behavioral bias that is unlikely
to change. Want to take advantage of it? Consider buying longer dated options
(LEAPs) instead of shorter-term options for your option rolling strategy.
Disclosure: I am/we are long SPY, IWM, EEM, QQQ. I wrote this
article myself, and it expresses my own opinions. I am not receiving
compensation for it (other than from Seeking Alpha). I have no business
relationship with any company whose stock is mentioned in this article.
Additional disclosure: I'm long call LEAPs on SPY, IWM, EEM, QQQ
(video, FYI, a class taught by Dr. Shiller at Yale, the Noble winner)
Chapter 9 Options and Futures
Class discussion
topics:
· Apple price will go up because of the
holiday shopping season. Google price could fall based on some news you just
heard. Anticipating large changes in stock prices of Apple and Google, how
shall you act?
· You just bought GM stocks. You worried
for GM price might fall. What can you do to ease your mind?
Options are derivative
contracts that give the holder the right, but not the obligation, to buy or
sell the underlying instrument at a
specified price on or before a specified future date. Although the holder
(also called the buyer) of the option is not obligated to exercise the
option, the option writer (known as the seller) has an obligation to buy
or sell the underlying instrument if the option is exercised.
Depending on the strategy, option trading can provide a variety of benefits
including the security of limited risk and the advantage of leverage. Options
can protect or enhance an investor’s
portfolio in rising, falling and neutral markets. Regardless of the
reasons for trading options or the strategy employed, it is important to
understand the factors that determine the value of an option. This tutorial
will explore the factors that influence option pricing, as well as several
popular option pricing models that are used to determine the theoretical
value of options. (www.investopedia.com)
CBOE free option calculator (great tool to calculate option
prices)
Call and Put price of AAPL on
Google Finance
Call and Put price of AAPL on Nasdaq
Call
Options & Put Options Explained Simply In 8 Minutes
Part
II: Futures
Futures market explained (video)
Discussion Topics:
·
Future market
F =
forward rate
S =
spot rate
r1 = simple interest rate of the term
currency
r2 = simple interest rate of the base
currency
Example
of Future market
·
https://www.cmegroup.com/trading/equity-index/us-index/bitcoin.html
·
Market data is delayed by at
least 10 minutes.
·
All market data contained within the CME Group website should be considered
as a reference only and should not be used as validation against, nor as a
complement to, real-time market data feeds. Settlement prices on instruments
without open interest or volume are provided for web users only and are not
published on Market Data Platform (MDP). These prices are not based on market
activity.
MONTH |
OPTIONS |
CHARTS |
LAST |
CHANGE |
PRIOR SETTLE |
OPEN |
HIGH |
LOW |
VOLUME |
HI / LOW LIMIT |
UPDATED |
||
OCT 2020 |
13105 |
+60 |
13045 |
13050 |
13180 |
13025 |
476 |
16955 / 9135 |
01:30:52 CT |
||||
NOV 2020 |
13260 |
+80 |
13180 |
13190 |
13310 |
13190 |
122 |
17130 / 9230 |
01:29:19 CT |
||||
DEC 2020 |
13400 |
+115 |
13285 |
13400 |
13425 |
13390 |
18 |
17270 / 9300 |
22:45:31 CT |
||||
JAN 2021 |
13510 |
+140 |
13370 |
13505 |
13510 |
13505 |
6 |
17380 / 9360 |
01:24:52 CT |
||||
FEB 2021 |
- |
- |
13420 |
- |
- |
- |
0 |
17445 / 9395 |
21:12:25 CT |
||||
MAR 2021 |
- |
- |
13460 |
- |
- |
- |
0 |
17495 / 9425 |
21:12:25 CT |
||||
APR 2021 |
- |
- |
0 |
- |
- |
- |
0 |
No Limit / No Limit |
18:21:33 CT |
||||
DEC 2021 |
- |
- |
14215 |
- |
- |
- |
0 |
18475 / 9955 |
21:12:25 CT |
All market data contained within the CME
Group website should be considered as a reference only and should not be used
as validation against, nor as a complement to, real-time market data feeds. Settlement
prices on instruments without open interest or volume are provided for web
users only and are not published on Market Data Platform (MDP). These prices
are not based on market activity.
https://www.cmegroup.com/trading/equity-index/us-index/bitcoin_quotes_settlements_futures.html
·
MONTH |
OPEN |
HIGH |
LOW |
LAST |
CHANGE |
SETTLE |
ESTIMATED VOLUME |
PRIOR DAY OPEN INTEREST |
OCT 20 |
13100.0 |
13300.0 |
12805.0 |
13035.0 |
+75. |
13045.0 |
6,031 |
7,928 |
NOV 20 |
13205.0 |
13445.0B |
12945.0 |
13160.0 |
+70. |
13180.0 |
1,519 |
2,279 |
DEC 20 |
13300.0 |
13560.0B |
13070.0 |
13310.0A |
+70. |
13285.0 |
499 |
1,719 |
JAN 21 |
13370.0 |
13655.0B |
13180.0A |
13345.0A |
+70. |
13370.0 |
168 |
177 |
FEB 21 |
- |
13680.0B |
13260.0A |
13680.0B |
+70. |
13420.0 |
0 |
14 |
MAR 21 |
- |
13740.0B |
13335.0A |
13740.0B |
+70. |
13460.0 |
0 |
5 |
DEC 21 |
- |
- |
- |
- |
+70. |
14215.0 |
0 |
3 |
Total |
8,217 |
12,125 |
·
o Home
Work
Please
refer the articles on the right and answer the following questions.
1. Who
are the buyers and sellers of the futures contract?
2. Why is there a futures market
for bitcoin?
Bullish option strategies example on optionhouse
Bearish option strategies example on optionhouse
Scott Nations, Contributor
They’re finally here. Exchange-traded bitcoin options
launched Monday on the Chicago Mercantile Exchange.
Traders of all stripes have been
desperate for exchange-traded options on bitcoin because options can be used
to define risk while expressing nearly any market thesis and it is that
ability to limit losses that is so important in bitcoin, which saw a 1,900%
rally in 2017 followed by an 82% break before bottoming late in 2018.
Traditional options allow the buyer of the option to purchase the
underlying asset in the case of a call option or sell the underlying in the
case of a put option. Options on futures are just a bit different
in that the owner of a call option has the right at option expiration to take
a long position in the bitcoin futures contract traded at the CME, while the
owner of a put option has the right to take a short position in those bitcoin
futures.
Regardless of the underlying
instrument, the ability to define risk comes at a cost. Options on bitcoin futures are incredibly expensive as you would
expect from anything with this sort of volatility. Traders usually refer
to the cost of an option in terms of “implied volatility,” or the amount of
volatility implied by that current price of the option.
Options on bitcoin futures are implying an extreme amount of volatility. Just after midday on Monday, the $8,000-strike put options
expiring in April were trading at 72%
implied volatility, suggesting that traders believe bitcoin is likely to be
between $6,965 and $9,940 when those April options expire. That’s a range
of 37% with bitcoin futures at $8,130. In comparison, the at-the-money April options for the S&P 500 are
trading below 12% implied volatility.
The buyer of a $9,000-strike call option expiring in April would
have to pay about $1,075 for the call, meaning
bitcoin futures would have to be above $10,075 for that call purchase to be
profitable at expiration. The buyer of an $8,000-strike put option expiring
in April would have to pay about $1,165, meaning bitcoin futures would have
to be below $6,835 at expiration for the put purchase to be profitable. That
would really require some movement.
Until options on
bitcoin futures gain a deeper following, any trader will face a market —
meaning the bid for any option and the offer price for that option — that is
very wide. For example, the market for those April $8,000 put options is
about 250 points wide.
That doesn’t mean option sellers
will have it any better off. The seller of a naked call option would face
unlimited losses if bitcoin were to resume the rally it enjoyed in 2017.
Options on bitcoin futures will likely be a great tool for speculators
in the cryptocurrency space. Speculators
in other asset classes have known for a long time that options offer the
ability to limit losses and create unique payoff profiles. And it’s always
good for investors and speculators to have more options.
Scott Nations is a CNBC contributor and president of Nations Indexes,
a financial engineering firm.
Bitcoin Futures - What You Need To Know (Hint: It's
Good News), BTC As Currency, CNBC - CMTV Ep75 (video, FYI)
Second Mid Term – 62 T/F questions on
10/29/2020
Chapter 11 Commercial Banking
System
PPT2 Commercial
banking II (Balance sheet)
Wells Fargo’s Income Statement and
balance sheet http://www.nasdaq.com/symbol/wfc/financials?query=balance-sheet
Period Ending: |
12/31/2019 |
12/31/2018 |
12/31/2017 |
12/31/2016 |
Total Revenue |
$103,915,000 |
$101,060,000 |
$97,741,000 |
$94,176,000 |
Cost of Revenue |
$8,635,000 |
$5,622,000 |
$3,013,000 |
$1,395,000 |
Gross Profit |
$0 |
$0 |
$0 |
$0 |
Operating Expenses |
||||
Research and Development |
$0 |
$0 |
$0 |
$0 |
Sales, General and Admin. |
$58,070,000 |
$55,068,000 |
$57,332,000 |
$51,185,000 |
Non-Recurring Items |
$0 |
$0 |
$0 |
$0 |
Other Operating Items |
$2,795,000 |
$2,802,000 |
$3,680,000 |
$4,962,000 |
Operating Income |
$0 |
$0 |
$0 |
$0 |
Add'l income/expense items |
$0 |
$0 |
$0 |
$0 |
Earnings Before Interest and Tax |
$34,415,000 |
$37,568,000 |
$33,716,000 |
$36,634,000 |
Interest Expense |
$10,217,000 |
$9,030,000 |
$6,339,000 |
$4,514,000 |
Earnings Before Tax |
$24,198,000 |
$28,538,000 |
$27,377,000 |
$32,120,000 |
Income Tax |
$4,157,000 |
$5,662,000 |
$4,917,000 |
$10,075,000 |
Minority Interest |
$2,843,000 |
$1,515,000 |
$1,779,000 |
$1,103,000 |
Equity Earnings/Loss Unconsolidated Subsidiary |
-$492,000 |
-$483,000 |
-$277,000 |
-$107,000 |
Net Income-Cont. Operations |
$22,392,000 |
$23,908,000 |
$23,962,000 |
$23,041,000 |
Net Income |
$19,549,000 |
$22,393,000 |
$22,183,000 |
$21,938,000 |
Net Income Applicable to Common Shareholders |
$17,938,000 |
$20,689,000 |
$20,554,000 |
$20,373,000 |
Period Ending: |
12/31/2019 |
12/31/2018 |
12/31/2017 |
12/31/2016 |
Current Assets |
||||
Cash and Cash Equivalents |
$808,756,000 |
$793,331,000 |
$831,835,000 |
$769,111,000 |
Short-Term Investments |
$0 |
$0 |
$0 |
$0 |
Net Receivables |
$0 |
$0 |
$0 |
$0 |
Inventory |
$0 |
$0 |
$0 |
$0 |
Other Current Assets |
$0 |
$0 |
$0 |
$0 |
Total Current Assets |
$0 |
$0 |
$0 |
$0 |
Long-Term Assets |
||||
Long-Term Investments |
$1,568,119,000 |
$1,525,758,000 |
$1,528,683,000 |
$1,492,375,000 |
Fixed Assets |
$9,309,000 |
$8,920,000 |
$8,847,000 |
$8,333,000 |
Goodwill |
$26,390,000 |
$26,418,000 |
$26,587,000 |
$26,693,000 |
Intangible Assets |
$0 |
$0 |
$0 |
$0 |
Other Assets |
$80,347,000 |
$81,293,000 |
$91,668,000 |
$115,947,000 |
Deferred Asset Charges |
$0 |
$0 |
$0 |
$0 |
Total Assets |
$1,927,555,000 |
$1,895,883,000 |
$1,951,757,000 |
$1,930,115,000 |
Current Liabilities |
||||
Accounts Payable |
$75,163,000 |
$69,317,000 |
$70,615,000 |
$57,189,000 |
Short-Term Debt / Current
Portion of Long-Term Debt |
$104,512,000 |
$105,787,000 |
$103,256,000 |
$96,781,000 |
Other Current Liabilities |
$1,322,626,000 |
$1,286,170,000 |
$1,335,991,000 |
$1,306,079,000 |
Total Current Liabilities |
$0 |
$0 |
$0 |
$0 |
Long-Term Debt |
$9,079,000 |
$8,499,000 |
$8,796,000 |
$14,492,000 |
Other Liabilities |
$0 |
$0 |
$0 |
$0 |
Deferred Liability Charges |
$0 |
$0 |
$0 |
$0 |
Misc. Stocks |
$838,000 |
$900,000 |
$1,143,000 |
$916,000 |
Minority Interest |
$0 |
$0 |
$0 |
$0 |
Total Liabilities |
$1,740,409,000 |
$1,699,717,000 |
$1,744,821,000 |
$1,730,534,000 |
Stock Holders Equity |
||||
Common Stocks |
$9,136,000 |
$9,136,000 |
$9,136,000 |
$9,136,000 |
Capital Surplus |
$166,697,000 |
$158,163,000 |
$145,263,000 |
$133,075,000 |
Retained Earnings |
-$68,831,000 |
-$47,194,000 |
-$29,892,000 |
-$22,713,000 |
Treasury Stock |
$61,049,000 |
$60,685,000 |
$60,893,000 |
$60,234,000 |
Other Equity |
-$2,454,000 |
-$7,838,000 |
-$3,822,000 |
-$4,702,000 |
Total Equity |
$187,146,000 |
$196,166,000 |
$206,936,000 |
$199,581,000 |
Total Liabilities &
Equity |
$1,927,555,000 |
$1,895,883,000 |
$1,951,757,000 |
$1,930,115,000 |
Wells Fargo’s Financial Ratios
For class discussion
1.
Anything
wrong with the above balance sheet of Wells Fargo? Where do the loans and
deposits go?
Finance & Accounting Facts :
Understanding Bank Financial Statements (VIDEO)
FRM: Bank Balance Sheet &
Leverage Ratio (VIDEO)
2. Why do we need banks?
3.
NIM – Net interest Margin – the profitability measure of banks
Net
Interest Margin (Video) https://www.investopedia.com/terms/n/netinterestmargin.asp
By ANDREW BLOOMENTHAL
Reviewed By
DAVID KINDNESS
Updated Jul
13, 2020
Net
interest margin (NIM) is a measurement comparing the net interest income a
financial firm generates from credit products like loans and mortgages, with
the outgoing interest it pays holders of savings accounts and certificates of
deposit (CDs). Expressed as a percentage, the NIM is a
profitability indicator that approximates the likelihood of a bank or
investment firm thriving over the long haul. This metric helps prospective
investors determine whether or not to invest in a given financial services
firm by providing visibility into the profitability of their interest income
versus their interest expenses.
Simply put: a positive net interest margin
suggests that an entity operates profitably, while a negative figure
implies investment inefficiency. In the latter scenario, a firm may take
corrective action by applying funds toward outstanding debt or shifting those
assets towards more profitable investments.
Consider the following fictitious example: Assume
Company ABC boasts a return on investment of $1,000,000, an interest expense
of $2,000,000, and average earning assets of $10,000,000. In this scenario,
ABC's net interest margin totals -10%, indicating that it lost more money due
to interest expenses than it earned from its investments. This firm would
likely fare better if it used its investment funds to pay off debts rather
than making this investment.
What Affects Net Interest Margin
Multiple factors may affect a financial
institution's net interest margin--chief among them: supply and demand. If
there's a large demand for savings accounts compared to loans, net interest
margin decreases, as the bank is required to pay out more interest than it
receives. Conversely, if there's a higher demand in loans versus savings
accounts, where more consumers are borrowing than saving, a bank's net
interest margin increases.
Monetary
policy and fiscal regulation can impact a bank's net interest margin as the
direction of interest rates dictate whether consumers borrow or save.
Monetary policies set by central banks also
heavily influence a bank's net interest margins because these edicts play a pivotal
role in governing the demand for savings and credit. When interest rates
are low, consumers are more likely to borrow money and less likely to save
it. Over time, this generally results in higher net interest margins.
Contrarily, if interest rates rise, loans become costlier, thus making
savings a more attractive option, which consequently decreases net interest
margins.
https://fred.stlouisfed.org/series/USNIM
http://www.bankregdata.com/allIEmet.asp?met=NIM&den=aa
4.
What is bank run? It is rare. Why?
Additionally,
the U.S. Congress established the Federal Deposit Insurance Corporation
(FDIC) in 1933. Created in response to the many bank failures that happened
in the preceding years, this agency insures bank deposits. Its mission is to
maintain stability and public confidence in the U.S. financial system.
But
in some cases, banks need to take a more proactive approach if faced with the
threat of a bank run. Here's how they may do it.
o
Slow it down. Banks may choose to shut down for a
period of time if they are faced with the threat of a bank run. This
prevents people from lining up and pulling their money out. Franklin D.
Roosevelt did this in 1933 after he assumed office. He declared a bank
holiday, calling for inspections to ensure banks' solvency so they could
continue operating.
o
Borrow. Banks may borrow from other institutions
if they don't have enough cash reserves. Large loans may stop them from going
bankrupt.
o
Insure deposits.
When people know their deposits are insured by the government, their fear
generally subsides. This has been the case since the U.S. established the
FDIC.
5.
Why are banks reluctant to lend out to small business, but offer loans to
homebuyers?
6. The
regulation: Basel III
For example, the bank has one million dollars that can be
lent out. Shall the bank lend it out to a small business owner or to a house
buyer?
Use the following information to make your judgment.
– Risk level of Example
0% US
gov bond
20% Muni
issued by city, state, and Fannie and Freddie
50% Mortgage
100% Anything
else such as loans to business
Basel III requires 7% of capital based on the risk
weighted assets (RWA).
Basel III in 10 minutes
Basel III is a 2009 international
regulatory accord that introduced a set of reforms designed to mitigate risk within
the international banking sector, by requiring
banks to maintain proper leverage ratios and keep certain levels of reserve
capital on hand.
Basel III was rolled out by the Basel
Committee on Banking Supervision—then a consortium of central banks from 28
countries, shortly after the credit crisis of 2008. Although the voluntary implementation deadline for the
new rules was originally 2015, the date has been repeatedly pushed back
and currently stands at January 1, 2022.
·
Basel
III is an international regulatory accord that introduced a set of reforms
designed to improve the regulation, supervision, and risk management within
the banking sector.
·
Basel
III is an iterative step in the ongoing effort to enhance the banking
regulatory framework.
·
A
consortium of central banks from 28 countries published Basil III in 2009,
largely in response to the credit crisis resulting from the 2008 economic
recession.
Understanding Basel III
Basel III, which is alternatively
referred to as the Third Basel Accord or Basel Standards, is part of the
continuing effort to enhance the international banking regulatory framework. It specifically builds on the Basel I and
Basel II documents in a campaign to improve the banking sector's ability to
deal with financial stress, improve
risk management, and promote transparency. On a more granular level, Basel III seeks to strengthen the
resilience of individual banks in order to reduce the risk of system-wide
shocks and prevent future economic meltdowns.
Minimum Capital Requirements by Tiers
Banks have two main silos of capital
that are qualitatively different from one another. Tier 1 refers to a bank's
core capital, equity, and the disclosed reserves that appear on the bank's
financial statements. In the event that a bank experiences significant
losses, Tier 1 capital provides a
cushion that allows it to weather stress and maintain a continuity of
operations. By contrast, Tier 2
refers to a bank's supplementary capital, such as undisclosed reserves and
unsecured subordinated debt instruments that must have an original maturity
of at least five years.
7.
Why
banks failed?
For discussion:
·
If a bank is in trouble, who can save
them?
·
What causes a bank to be insolvent?
8.
Too big to fail.
What is too big
to fail (Bloomberg university) video
Warren Buffett on Too Big to Fail (video)
How can you tell that
banks are getting bigger and bigger? Who need big banks? --- for class
discussion
Homework Chapter 11
(Due with final)
Question 1: Pick a commercial bank in US and an
investment bank. Compare the two companies in terms of firm assets, liability
and equity, scope of business, ROE, in 2019. Draw conclusions based on your observation.
Question 2: what is bank run? Shall we worry
about the occurrence of bank run? Why or why not?
Question
3: What is Basel III? Should the
government regulate banks?
Question 4: What is too big to fail? How can a
bank become so big? Can a big bank fail? Why or why not?
Question 5: Why is hard for small business to
get loan from banks? (read the paper on the right)
·
https://www.youtube.com/watch?v=Ssa5WNnbGsw&feature=relmfu
·
https://www.youtube.com/watch?v=bhBQizelZP8&list=ULbhBQizelZP8
Why banks lending to small business isn’t
recovering?
By
Brayden McCarthy, 9/9/2020
https://www.fundera.com/business-loans/guides/bank-lending-small-businesses-isnt-recovering
When
you hear the words “small business lender”, you may imagine a calculator-clutching community banker
who spends his time carefully scrutinizing entrepreneur’s
financial statements. But increasingly these days that’s
anachronistic. Banks have moved from
being community-focused to being Fed-focused, and small business lending is less of a
priority. That’s why if you talk to any small
business owner about the biggest obstacles to their growth, it won’t take long for the conversation to turn to capital
access.
In fact, about 80 percent of small business owners
who apply for a bank loan get rejected. That’s a staggering number, and
it’s easy to think that this is just a ripple effect
of the financial crisis of 2008. After all, banks almost by definition
tighten the credit spigot during a banking crisis, and there’s
no question that the crash is partly responsible for the 20 percent decline
in small-business lending from the pre-crisis boom. Moreover, terms on small business loans tightened during the crisis,
and have loosened much less for small firms than for large firms during the
recovery.
But, that’s not the whole story. The truth is that over the past two
decades, small business loans have fallen from about half to under 30 percent
of total bank loans. That secular
decline is due to a multitude of factors, including high transaction costs of small business loans and regulators
that push banks to hold more capital against business loans than consumer
loans, further driving up the costs of small-business lending.
As a result, it’s
increasingly difficult for small businesses to find banks willing to lend to
them. One study, for example, noted that the average small business owner has
to approach multiple banks and spend about three to four full days of man
hours filling out applications before they can find a bank willing to lend to
them. So, instead of catalyzing the
recovery, bank credit markets are choking off growth and job creation for
some small businesses. That’s a dangerous dynamic, and we need to arrest
it.
I recently co-authored
an independent Harvard Business School working paper entitled ‘The State of Small Business
Lending: Credit Access During the Recovery and How Technology May Change the
Game’ that bifurcates the problem, which can be accessed here. Below we include an excerpt from
the paper’s executive summary.
Small
businesses are critical to job creation in the U.S. economy.
Small
businesses create two out of every three net new jobs. Small
firms employ half of the private sector workforce, and since 1995 small
businesses have created about two out of every three net new jobs—65 percent of total net job creation. Most small
businesses are Main Street businesses or sole proprietorships. Of America’s 28.7
million small businesses, half of all small firms are home-based, and 23
million are sole proprietorships. The remaining 5.7 million small firms have
employees, and can be divided up into Main Street mom and pop businesses,
small-and medium-sized suppliers to larger corporations, and high-growth
startups.
Small
businesses were hit harder than larger businesses during the 2008 financial
crisis, and have been slower to recover from a recession of unusual depth and
duration.
Small firms were hit
harder than large firms during the crisis, with the smallest firms hit hardest. Between 2007 and
2012, the small business share of total net job losses was about 60 percent.
From the employment peak before the recession until the last low point in
March 2009, jobs at small firms fell about 11 percent. By contrast, payrolls
at larger businesses shrank by about 7 percent. This disparity was even more
significant among the smallest of small businesses. Jobs declined 14.1
percent in establishments with fewer than 50 employees, compared with 9.5
percent in businesses with 50 to 500 employees, while overall employment
decreased 8.4 percent.
Financial crises tend to
hit small firms harder than large firms. As the academic literature underscores, small firms are always hit harder during
financial crises because they are more dependent on bank capital to fund
their growth. Credit markets act
as a “financial accelerator”
for small firms, such that they feel the credit market swings up and down
more acutely.
Small businesses are
back to creating two out of every three net new jobs in the U.S., but there
remains a significant jobs gap. Small businesses have created jobs in every
quarter since 2010, and are back to creating two out of every three net new
jobs. But, as Brookings data reveals, we are still well below the job
creation levels that we need to see to fill the “jobs
gap” left in the wake the recession.
Bank
credit, particularly through term loans, is one of the primary sources of
external financing for small businesses—especially
Main Street firms—and is key to helping small firms
maintain cash flow, hire new employees, purchase new inventory or equipment,
and grow their business.
Bank loans have
historically been critical for small businesses. Unlike large firms, small businesses lack access to
public institutional debt and equity capital markets and the vicissitudes of small
business profits makes retained earnings a necessarily less stable source of
capital. About 48 percent of business owners report a major bank as their
primary financing relationship, with another 34 percent noting that a
regional or community bank is their main financing partner for capital.
In
the current lending environment, where you sit often determines where you
stand on the question of, is there a gap in access to bank credit for small
businesses? Most banks say they are lending to small businesses, but major
surveys of small business owners point to constrained credit markets.
Bankers
say they are lending to small businesses, but have trouble finding
creditworthy borrowers. Banks today say that they are increasing
their lending to small businesses but that the recession has had a lingering
effect on the demand from small business borrowers. In addition, bankers note
the dampening effect of increased regulatory oversight on the availability of
small business credit. Not only is
there more regulation and higher compliance costs, there is uncertainty about
how regulators view the credit characteristics of loans in their portfolios,
making them less likely to make a loan based on “softer” underwriting
criteria such as knowledge of the borrower from a long term relationship. Jamie
Dimon, CEO and Chairman of JP Morgan Chase, noted in 2013 that, ‘Very few
(small businesses) say, ‘I can’t get a loan.’
Sometimes they say that, and it is true. I would say that happens more in
smaller towns, where smaller banks are
having a hard time making loans because the examiners are all over them”.
Small businesses claim
that loans are still difficult to get during the recovery. Some level of friction in small business credit
markets is natural, and indicative of a financial sector working to allocate
scarce resources to their most productive ends. It is also difficult to
assess whether or not small firms being denied credit access are in fact
creditworthy. Nonetheless, every major survey points to credit access being a
problem and a top growth concern for small firms during the recovery,
including national surveys conducted by the National Federation of
Independent Businesses (NFIB) and regional surveys led by the Federal
Reserve.
The
data on the small business credit gap is limited and inconclusive, but raises
troubling signs that access to bank credit for small businesses was in steady
decline prior to the crisis, was hit hard during the crisis, and has
continued to decline in the recovery as banks focus on more profitable market
segments.
Small business lending
continues to fall, while large business lending rises. In an absolute sense, small business loans on the
balance sheets of banks are down about 20 percent since the financial crisis,
while loans to larger businesses have risen by about 4 percent over the same
period.
The
banking industry in the aggregate appears increasingly less focused on small
business lending. The share of small business loans of
total bank loans was about 50 percent in 1995, but only about 30 percent in
2012. Moreover, small business owners report that competition among banks for
their business peaked in the 2001 to 2006 period, and has sharply declined
from 2006 to the present.
During
the 2008 financial crisis, small businesses were less able to secure bank
credit because of a ‘perfect storm’ of falling sales, weakened collateral and
risk aversion among lenders. There are some lingering cyclical factors from
the crisis that may still be constraining access to bank credit.
Small business sales were
hit hard during the crisis and may still be soft, undermining their demand
for loan capital. Income
of the typical household headed by a self-employed person declined 19
percent in real terms between 2007 and 2010, according to the Federal
Reserve’s Survey of Consumer Finances. And, the NFIB survey notes that small
businesses reported sales as their number one problem for four straight years
during the crisis and subsequent recovery.
Collateral owned by
small businesses was hit hard during the financial crisis, potentially making
small business borrowers less creditworthy today. Small business credit scores are lower now than
before the Great Recession. The Federal Reserve’s
2003 Survey of Small Business Finances indicated that the average PAYDEX
score of those surveyed was 53.4. By contrast, the 2011 NFIB Annual Small
Business Finance Survey indicated that the average small company surveyed had
a PAYDEX score of 44.7. Moreover, the values of both commercial and
residential real estate which represent two-thirds of the assets of small
business owners, and are often used as collateral for small business loans,
were hit hard during the financial crisis.
Banks
are more risk averse in the recovery. Measures of tightening
on loan terms including the Federal Reserve Senior Loan Officer Survey,
increased at double-digit rates during the recession and recovery for small
businesses, and have loosened at just single-digit rates over the past
several quarters. Loosening has been much slower and more tentative for small
firms than for large firms.
Community bank failures
increased and few new banks have started up. Troubled and failed banks reached levels not seen
since the Great Depression during the financial crisis of 2008, with the
failures consisting mostly of community banks—the
most likely institutions to lend to small firms. This environment—where troubled local banks appear unable to meet re-emerging
small firm credit needs—would be an ideal market for
new banks to emerge, but new charters are down to a trickle. A year recently
went by with no new bank charters—the first time in
80-year history of the FDIC.
Regulatory overhang may
be hurting small business lending. Banks continue to raise capital levels to
appease risk averse bank examiners and other regulators post-‐‑crisis, undermining their ability to
underwrite small business loans, which are inherently riskier than consumer
and large business lending. Federal Reserve economists have recently modeled
that additional regulatory burdens are forcing banks to hire additional full-‐‑ time employees focused on oversight and
enforcement, which can hurt the return on assets of some community banks by
as much as 40 basis points. Moreover, other studies have found that an
elevated level of supervisory stringency during the most recent recession is
likely to have a statistically significant impact on total loans and loan
capacity for several years—approximately 20 quarters—after the onset of the tighter supervisory standards.
There
also appear to be structural barriers that are impeding bank lending to small
businesses, including consolidation of the banking industry, high search
costs and higher transaction costs associated with small business lending.
A decades-long trend
toward consolidation of banking assets in fewer institutions is eliminating a
key source of capital for small firms. Community banks are being consolidated by big
banks, with the number of community banks falling to less than 7,000 today,
down from over 14,000 in the mid-1980s, while average bank assets continues
to rise. This trend was exacerbated by the financial crisis. The top 106
banks with greater than $10 billion in assets held 80 percent of the nation’s $14 trillion in financial assets in 2012, up from 116
firms with 69 percent of $13 trillion in assets in 2007.
Search costs in small
business lending are high, for both borrowers and lenders. It is difficult
for qualified borrowers to find willing lenders, and vice versa. Federal
Reserve research finds that small business borrowers often spend almost 25
hours on paperwork for bank loans and approach multiple banks during the
application process. Successful applicants wait weeks or, in some cases, a
month or more for the funds to actually be approved and available. Some banks
are even refusing to lend to businesses within particular industries (for
example, restaurants) or below revenue thresholds of $2 million.
Small
business loans, often defined as business loans below $1 million, are
considerably less profitable than large business loans.
Investment banks
1. What is investment banking: https://www.investopedia.com/terms/i/investment-banking.asp
(video)
Investment
banking is a specific division of banking related to the creation of capital for
other companies, governments, and other entities.
·
underwrite new debt and equity securities for
all types of corporations,
·
aid in the sale of securities,
·
help to facilitate mergers and acquisitions, reorganizations, and
broker trades for both institutions and private investors.
·
provide guidance to issuers regarding the issue
and placement of stock.
For example: the scope of investment banks
· Market Making
· Merger and Acquisition Advisory
· Prop trading
· IPO and SEO underwriter
· Structured financial products
Example of
Investment Banking
Suppose that
Pete’s Paints Co., a chain supplying paints and other hardware, wants to go public.
Pete, the owner, gets in touch with Jose, an investment banker working for a
larger investment banking firm. Pete and Jose strike a deal wherein Jose (on
behalf of his firm) agrees to buy 100,000 shares of Pete’s Paints for the
company’s IPO at the price of $24 per share, a price at which the investment
bank’s analysts arrived after careful consideration.
The investment
bank pays $2.4 million for the 100,000 shares and, after filing the
appropriate paperwork, begins selling the stock for $26 per share. Yet, the
investment bank is unable to sell more than 20% of the shares at this price
and is forced to reduce the price to $23 per share in order to sell the
remaining shares.
For the IPO
deal with Pete’s Paints, then, the investment bank has made $2.36 million
[(20,000 x $26) + (80,000 x $23) = $520,000 + $1,840,000 = $2,360,000]. In
other words, Jose’s firm has lost $40,000 on the deal because it overvalued
Pete’s Paints.
Investment
banks will often compete with one another for securing IPO projects, which
can force them to increase the price they are willing to pay to secure the
deal with the company that is going public. If competition is particularly
fierce, this can lead to a substantial blow to the investment bank’s bottom line.
Most often,
however, there will be more than one investment bank underwriting securities in this
way, rather than just one. While this means that each investment bank has
less to gain, it also means that each one will have reduced risk.
Investment banks’ earning potential:
http://graphics.wsj.com/bank-earnings/
2. Hedge fund, private
equity, venture capital
§
Hedge
fund: video
by khan academy
§ Private equity and venture
capital Video
by khan academy
3. Causes of 2008
Financial Crisis
What Is a
Mortgage-Backed Security (MBS)? https://www.investopedia.com/terms/m/mbs.asp
A mortgage-backed
security (MBS) is an investment similar to a bond that is made up of a bundle
of home loans bought from the banks that issued them. Investors in MBS
receive periodic payments similar to bond coupon payments.
The MBS is a
type of asset-backed security. As became
glaringly obvious in the subprime
mortgage meltdown of 2007-2008, a mortgage-backed security is only as sound
as the mortgages that back it up.
How a
Mortgage-Backed Security Works
Essentially, the mortgage-backed security turns the bank
into a middleman between the homebuyer and the investment industry. A
bank can grant mortgages to its customers and then sell them on at a discount
for inclusion in an MBS. The bank records the sale as a plus on its balance
sheet and loses nothing if the homebuyer defaults sometime down the road.
The investor who buys a mortgage-backed security
is essentially lending money to home buyers. An MBS can be bought and
sold through a broker.
The Role of
MBSs in the Financial Crisis
Mortgage-backed securities played a central role in the financial crisis that
began in 2007 and went
on to wipe out trillions of dollars in wealth, bring down Lehman
Brothers, and
roil the world financial markets.
In retrospect, it seems
inevitable that the rapid increase in home prices and the growing demand for
MBS would encourage banks to lower their lending standards and drive
consumers to jump into the market at any cost.
That was the beginning of
the subprime MBS. With Freddie
Mac and Fannie Mae aggressively
supporting the mortgage market, the
quality of all mortgage-backed securities declined and their ratings became
meaningless. Then, in 2006, housing prices peaked.
Subprime borrowers started to default and the housing market
began its long collapse. More people began walking away from their mortgages
because their homes were worth less than their debts. Even the conventional
mortgages underpinning the MBS market saw steep declines in value. The
avalanche of non-payments meant that many MBSs and collateralized debt
obligations (CDO) based off of pools of mortgages were vastly overvalued.
The losses piled up as institutional investors and banks tried
and failed to unload bad MBS investments. Credit tightened, causing many
banks and financial institutions to teeter on the brink of insolvency. Lending was disrupted to
the point that the entire economy was at risk of collapse.
In the end, the U.S. Treasury stepped in with a $700 billion
financial system bailout intended to ease the credit crunch. The Federal
Reserve bought $4.5 trillion
in MBS over a period of years while the Troubled Asset Relief Program (TARP) injected capital directly into banks.
The financial crisis
eventually passed, but the total government commitment was much larger than the $700 billion figure often cited.
A credit default swap (CDS) is a financial derivative or contract that allows an investor to
"swap" or offset his or her credit risk with that of another investor. For example,
if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to
offset or swap that risk. To swap the
risk of default, the lender buys a CDS from another investor who agrees to
reimburse the lender in the case the borrower defaults.
A credit default swap is designed to transfer the credit exposure of fixed income products between two
or more parties. In a CDS, the buyer of the swap makes
payments to the swap's seller until the maturity date of a contract. In
return, the seller agrees that – in the event that the debt
issuer (borrower) defaults or experiences another credit event – the seller will pay the buyer the
security's value as well as all interest payments
that would have been paid between that time and the security's maturity
date.
Bonds and other debt
securities have risk that the borrower will not repay the
debt or its interest. Because debt securities will often have
lengthy terms to maturity, as much as 30 years, it is
difficult for the investor to make reliable estimates about that risk over
the entire life of the instrument.
Credit default
swaps have become an extremely popular way to manage this kind of risk. The
U.S. Comptroller of the Currency issues a quarterly report on credit
derivatives and in a report issued in
June 2020, it placed the size of the entire market at $4 trillion, of
which CDS accounted for $3.5 trillion.
Real World
Example of a Credit Default Swap
Credit default
swaps were widely used during the European Sovereign Debt crisis. In September
2011, Greece government bonds had a 94% probability of default. Many hedge
funds even used CDS as a way to speculate on the likelihood that the country
would default.
What is the Shadow
Banking System? https://www.investopedia.com/terms/s/shadow-banking-system.asp
(video)
A shadow banking system is the group of financial
intermediaries facilitating the creation
of credit across the global financial system but
whose members are not subject to regulatory oversight. The shadow banking system also refers to unregulated activities by
regulated institutions. Examples of intermediaries not subject to
regulation include hedge funds, unlisted derivatives, and other unlisted
instruments, while examples of unregulated activities by regulated
institutions include credit default swaps.
Understanding Shadow Banking
Systems
The shadow banking system
has escaped regulation primarily because unlike traditional banks and credit
unions, these institutions do not accept traditional deposits. Shadow banking
institutions arose as innovators in financial markets who were able to
finance lending for real estate and other purposes but who did not face the normal regulatory
oversight and rules regarding capital reserves and liquidity that are
required of traditional lenders in order to help prevent bank failures, runs
on banks, and financial crises.
As a result, many of the
institutions and instruments have been able to pursue higher market, credit,
and liquidity risks in their lending and do not have capital
requirements commensurate
with those risks. Many shadow banking
institutions were heavily involved in lending related to the boom in subprime
mortgage lending and loan securitization in the early 2000’s. Subsequent
to the subprime meltdown in 2008, the activities of
the shadow banking system came under increasing scrutiny due to their role in
the over-extension of credit and systemic risk in the financial system and
the resulting financial crisis.
Who Is Watching the Shadow
Banks?
The shadow banking industry
plays a critical role in meeting rising credit demand in the United States.
Although it's been argued that shadow banking's disintermediation can increase economic
efficiency, its operation outside of traditional banking regulations raises
concerns over the systemic risk it may pose to the
financial system. The reforms enacted
through the 2010 Dodd-Frank
Wall Street Reform and Consumer Protection Act focused
primarily on the banking industry, leaving the shadow banking sector largely
intact. While
the Act imposed greater liability on financial companies selling exotic
financial products, most of the non-banking activities are still unregulated.
The Federal Reserve Board has proposed
that non-banks, such as broker-dealers, operate under similar margin
requirements as banks. Meanwhile, outside of the United States, China
began issuing directives in 2017 directly targeting risky financial practices
such as excessive borrowing and speculation in equities.
Shadow banking: still big, still dangerous (video)
4. Dodd Frank Act
The Dodd-Frank Wall Street
Reform and Consumer Protection Act is a massive piece of financial reform
legislation that was passed in 2010,
during the Obama administration. It was created as a response to
the financial crisis of 2008. Named after sponsors Senator Christopher
J. Dodd (D-Conn.) and Representative Barney Frank (D-Mass.), the act contains
numerous provisions, spelled out over roughly 2,300 pages, that were to be implemented
over a period of several years.
The Dodd-Frank Wall Street
Reform and Consumer Protection Act—typically shortened to just the Dodd-Frank
Act—established a number of new
government agencies tasked with overseeing the various components of the act
and, by extension, various aspects of the financial system. When Donald Trump was elected President
in 2016, he pledged to repeal Dodd-Frank; in May 2018, the Trump
administration signed a new law rolling back significant portions of it.
Another key component of
Dodd-Frank, the Volcker Rule,
restricts the ways banks can invest, limiting speculative trading, and
eliminating proprietary trading. Banks are not allowed to be involved with hedge funds or private equity
firms, which are considered too risky. In an effort to minimize possible
conflicts of interest, financial firms
are not allowed to trade proprietarily without sufficient "skin in the
game." The Volcker Rule is clearly a push back in the
direction of the Glass-Steagall Act of 1933, which first recognized
the inherent dangers of financial entities extending commercial and
investment banking services at the same time.
The
act also contains a provision for regulating derivatives, such as
the credit default swaps that were widely blamed for contributing
to the 2008 financial crisis. Dodd-Frank set up centralized exchanges for
swaps trading to reduce the possibility of counterparty default and
also required greater disclosure of swaps trading information to increase
transparency in those markets. The
Volcker Rule also regulates financial firms' use of derivatives in an attempt
to prevent "too big to fail" institutions from taking large risks
that might wreak havoc on the broader economy.
5.
President Trump deregulates Dodd Frank Act
Criticisms of
the Dodd-Frank Wall Street Reform and Consumer Protection Act
Proponents of
Dodd-Frank believed the Act would prevent the economy from experiencing a
crisis like that of 2008 and protect consumers from many of the abuses that
contributed to the crisis. Detractors,
however, have argued that the act could harm the competitiveness of U.S.
firms relative to their foreign counterparts. In particular, they contend
that its regulatory compliance
requirements unduly burden community banks and smaller financial
institutions—despite the fact that they played no role in causing the
financial crisis.
The higher reserve requirements under
Dodd-Frank mean banks must keep a higher percentage of their assets in cash,
which decreases the amount they are able to hold in marketable securities. In effect, this limits the bond
market-making role that banks have traditionally undertaken. With banks
unable to play the part of a market maker, prospective
buyers are likely to have a harder time finding counteracting sellers. More
importantly, prospective sellers may find it more difficult to find
counteracting buyers.
PUBLISHED THU, MAY 24 201812:14 PM EDTUPDATED THU, MAY 24 20187:45 PM EDT by Jacob Pramuk (video)
President Donald Trump signed the biggest rollback of bank regulations
since the global financial crisis into law Thursday.
The measure designed
to ease rules on all but the largest banks passed
both chambers of Congress with bipartisan support. Backers say the legislation
will lift burdens unnecessarily put on small and medium-sized lenders by the
Dodd-Frank financial reform act and boost economic growth.
Opponents, however,
have argued the changes could open taxpayers to more
liability if the financial system collapses or increase the chances of discrimination
in mortgage lending.
“Dodd-Frank was something they said could not be
touched. And honestly, a lot of great Democrats knew that it had to be done
and they joined us in the effort,” Trump said before he signed the bill, surrounded
by lawmakers from both major parties. “And there is something so nice about
bipartisan, and we’re going to have to try more of it. Let’s do more of it.”
The measure eases restrictions on all but the largest
banks. It raises the threshold to $250
billion from $50 billion under which banks are deemed too important to the
financial system to fail. Those institutions also would not have to undergo
stress tests or submit so-called living wills, both safety valves designed to
plan for financial disaster.
It eases
mortgage loan data reporting requirements for the overwhelming majority of
banks. It would add some safeguards for student loan borrowers and also require
credit reporting companies to provide free credit monitoring services.
Republicans have made slashing regulations one
of their top priorities since Trump took office in January 2017. But Democrats,
who largely support the Dodd-Frank reforms, helped to get the bank regulation
bill through Congress. Seventeen Democratic senators voted for the bill,
while 33 House Democrats supported it.
“When the president
signs this, we put community banks back in the mortgage lending business, which is really exciting for me,” Sen. Heidi Heitkamp, D-N.D., told CNBC on Wednesday.
The senator said her colleagues who
opposed it did so not because of community banking policies but because of the
restrictions lifted on mid-sized and regional institutions.
Some Republicans, such as House Financial Services
Committee Chairman Jeb Hensarling, argue the
legislation did not go far enough to roll back regulations on banks. Certain
lawmakers have pushed for a repeal of most or all of Dodd-Frank.
KEY POINTS
·
President Donald Trump signs a bill rolling back
certain bank regulations into law.
·
The law, which Congress passed with bipartisan
support, eases rules on all but the largest institutions.
·
Proponents argue the measures will help
community lenders, while opponents contend it went too far to help mid-sized
and regional firms.
Homework
(due with final)
1.
What is
MBS?
2.
What is
credit default swap?
3.
What is
shadow banking system
4.
What is
Dodd Frank Act?
5.
Do you
support deregulating Dodd Frank Act? Why or why not?
Wells Fargo tumbles, but Citigroup and
JPMorgan shares jump—5 experts speak Survival of the fittest? (FYI)
As the
big banks kick off earnings season with their quarterly reports, they are
shedding light on two sides of banking that are faring very differently
during the pandemic, market analysts say.
JPMorgan
Chase’s results came in strong, with the firm reporting record revenue. On
the other side of the spectrum was Wells Fargo, which said it lost $2.4
billion in the second quarter.
Here’s
what five Wall Street professionals, including CNBC’s Jim Cramer, said about
the banks on Tuesday:
‘What’s
the catalyst?’
Aperture
Investors Chairman and CEO Peter Kraus wondered if one of JPMorgan’s main
catalysts this quarter could last:
“We
expected trading income to be pretty robust and it turned out to be the case.
That’s not surprising. We had an enormously fast-moving, very active market
over the last three months, so, you would expect trading revenues to be good.
They’re probably a little bit better than what people expected. But then the
question is: is that trading revenue really sustainable? And you’re going to
see that going into the future and that’s [where] consumer income is actually
more predictive of what we might actually see in the next three months to six
months. … The banks are cheap. There’s no doubt about that. But the question
is what’s the catalyst that’s going to drive those earnings faster than the
catalyst that drives the earnings in other investments?”
Long-term
turnaround
Marty
Mosby, director of bank and equity strategies at Vining Sparks, said Wells
Fargo was more of a long-term bet:
“Wells
Fargo’s a long-term ... turnaround story. We’ll have to see how the
management team can now go from reconstructing and really not having any
expectation on what they do this year to what they build towards in earnings
power as we go into next year. Cutting the dividend to where it is gives them
a little bit of wiggle room, so, this provides a base [and] gets their yield
down to about where the market is. But there’s several other banks that have
[gotten] ahead of the curve in a sense of their credit. The market is
discounting them more because they think they’re going to have credit from
the last recession, but they’ve done a lot better and they’ve also
restructured their balance sheets. So, those are the banks that we really
want to look at now. Wells Fargo’s a play as you go into, I think, 2021 or
2022.”
Winners
and losers
Joe
Terranova, chief market strategist at Virtus Investment Partners and a
regular on CNBC’s “Halftime Report,” highlighted the differences between
JPMorgan and Wells Fargo’s performance:
“There’s
clearly a bifurcation between winners and losers. Just listen to the
commentary from [Wells Fargo CEO] Charlie Scharf, who talks about being
unsure about the length and severity of the economic downturn, and then read
what [JPMorgan Chase CEO] Jamie Dimon says where he talks about the fortress
balance sheet and being a port in the storm. So, on the money center banks, I
think, clearly, JPMorgan is benefiting from trading revenue as a catalyst. I
think that the technological investments that they have made over the prior
years is allowing them, during this pandemic, to reach their customers in a
more efficient [manner] than the other money center banks and I think that’s
the reason why investors should be owning JPMorgan.”
‘Don’t
own my stock’
Cramer,
who hosts CNBC’s “Mad Money,” deciphered Wells Fargo’s earnings commentary:
“Charlie
Scharf is a great banker. He’s got a very great pedigree. Visa. He was Bank
of New York. But he comes out and basically says, ‘Don’t own my stock. You
don’t want to touch my stock.’ And … Melissa [Lee] asked an analyst, ‘Is it a
contrarian play?’ and I look at it and I say, ‘Well, let me check with
Charlie Scharf, the CEO.’ Oops! No. Don’t buy it. Now, if you want to come in
and buy it, you don’t really have Charlie’s blessing. I always like it when
the CEO likes their stock, but maybe this is just one of those rare occasions
because he bought a ton of stock at [$]28 and it is no longer at 28. You can
buy it less than he did, but this is not the Jamie Dimon called shot that we
all remember. … Wells Fargo’s a bank. It’s like Monopoly. It’s the community
chest. And it’s a very good bank, but they do not have those trading desks
that are crushing it. JPMorgan, by the way, had a great trading desk
experience.”
The
‘all-clear sign’
David
Konrad, managing director of equity research at D.A. Davidson, predicted the
banks were unlikely to get an “all-clear sign” until 2021:
“I thought
Jamie was pretty confident on the JPM call about the dividend, where it is
and where the capital is. But, of course, a severe W-shaped economy puts that
at risk. And so … getting through the next few quarters with better
visibility of the dividend, and I think … looking at 1Q, 2Q of next year,
kind of peaking credit costs, I think the market wants to see not only
provisions coming way down, which, I think we’ll see that, but I think it’ll
be tough for the banks to work with net charge-offs still ramping up. We want
to see that delta come down as well. So, I think the big all-clear sign will
be more mid next year.”
In trading results, Wall Street's big banks find some
relief from tumultuous Q2 (FYI)
·
·
AuthorDeclan Harty
·
ThemeBankingFintechFixed Income
·
SegmentBanking
·
TagsGlobal
·
For Wall Street's biggest banks, 2020 is shaping up to be a heyday for
trading.
JPMorgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc.,
Morgan Stanley and Bank of America Corp. all saw double-digit spikes in
trading revenues during the second quarter as financial markets around the
world reacted to the continued fallout from the COVID-19 pandemic.
"Trading revenues benefit from uncertainty and high
volatility," Stephen Biggar, director of financial institutions research
at Argus Research, said in an interview. "A whole slate of asset classes
went for a wild ride in the second quarter."
In the U.S. equity market, for instance, the Cboe Volatility Index, a
widely used gauge of implied volatility based on the S&P 500, had an
average daily closing value of 34.49 in the second quarter. That was the
highest quarterly average since the first three months of 2009, according to
Cboe Global Markets Inc. data.
At JPMorgan, trading helped push the largest U.S. bank's quarterly
revenues to a record high even as net income fell year over year. Revenues
for JPMorgan's market and securities services unit, the business line that
includes fixed-income and equity trading, jumped to $11.33 billion in the
second quarter versus $6.39 billion a year ago. Fixed-income trading was up
99% year over year, while equities rose 38%. Citigroup posted a nearly 50%
revenue increase in its markets and securities services business, driven by a
68% surge in fixed-income trading. Equity trading revenues for Citigroup fell
about 3% year over year. Bank of America, the third big U.S. bank more
focused on deposits, saw sales and trading revenue climb 31.3% in the second
quarter year over year. Fixed income, currencies and commodities trading
revenues climbed 50% in that period, while equities revenues increased 7%.
Still, JPMorgan, Citigroup and Bank of America reported lower profits
across their entire companies in the second quarter largely due to dramatic
increases in both banks' provisions for loan losses.
Goldman, on the other hand, posted a slight year-over-year increase to
its quarterly profits — thanks almost entirely to its traders and investment
bankers. Net revenues for Goldman's global markets business jumped 93% to
$7.18 billion in the second quarter versus $3.72 billion a year ago.
Fixed-income, currencies and commodities trading revenues grew 149% in that
same period to a nine-year high, while revenues for equities swelled 46% to
their highest quarterly level in 11 years. Investment banking reached record
quarterly net revenues in the second quarter as well, Goldman said in its
July 15 earnings report.
"There's no question that over the last decade in a period of
very low interest rates and low volatility that [trading] has been a more
commoditized service," Goldman Chairman and CEO David Solomon said July
15 during an earnings call. "In a period where there's enormous change
and enormous volatility in markets, we became super busy because our clients
are super busy."
Morgan Stanley was the biggest standout, posting a 50.2%
year-over-year spike in earnings applicable to common shareholders. Sales and
trading revenues surged 68% from the prior year, with fixed income trading up
167.7% and equities higher by 23%.
The market's second-quarter swings made the first half of 2020 one of
the most robust opportunities for big bank trading desks in recent years.
A steady climb in asset prices in the wake of the 2008 financial
crisis, along with several reforms designed to limit risk-taking by the
biggest Wall Street banks, made for a challenging environment in recent years
for most of those companies' trading desks. Executives at the largest U.S.
banks have worked since then to push their companies further into steadier
revenue sources such as wealth management and consumer banking.
The boon to trading activity in the first half may be only a blip,
however.
Even as the coronavirus rages on in certain parts of the U.S.,
financial markets began to stabilize late in the second quarter and have
continued to steadily rise in the first few weeks of July. JPMorgan Chairman
and CEO Jamie Dimon said that trading, as a result, is not going to be nearly
as active in the coming quarters.
"You should assume it's going to fall in half," Dimon said
of trading revenues on a July 14 conference call. "We don't assume we
have these unbelievable trading results going forward. And hopefully, we'll
do better than that, but we simply don't know."
Federal Reserve and Monetary Policy
Part I - Fed Introduction
The Structure
of the Federal Reserve System is unique among central banks,
with both public and private aspects. It is described as
"independent within the government" rather than "independent
of government.
The Federal Reserve does not
require public funding, instead it remits its profits to the federal
government. It derives its authority and purpose from the Federal
Reserve Act, which was passed by Congress in 1913 and is subject to
Congressional modification or repeal.
The Federal Reserve System is composed of five parts.
1.
The presidentially appointed Board of Governors (or Federal Reserve Board),
an independent federal government agency located
in Washington, D.C.
2.
The Federal Open
Market Committee (FOMC), composed of the seven members of the
Federal Reserve Board and five of the twelve Federal Reserve Bank presidents,
which oversees open market operations, the principal tool of U.S.
monetary policy.
3.
Twelve regional Federal
Reserve Banks located
in major cities throughout the nation, which divide the nation into twelve
Federal Reserve districts. The Federal Reserve Banks act as fiscal agents for
the U.S. Treasury, and each has its own nine-member board of directors.
4.
Numerous other private
U.S. member banks, which own required amounts of non-transferable stock in
their regional Federal Reserve Banks.
5.
Various advisory
councils.
The Board of Governors of the Federal Reserve System, commonly known
as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is
charged with overseeing the Federal Reserve Banks and with helping implement the monetary
policy of the United States. Governors are appointed by the president of the United States and
confirmed by the Senate for
staggered 14-year terms.
The Chair and Vice Chair of the Board are two
of seven members of the Board of
Governors who are appointed by the President from among the sitting Governors.
The terms of the seven members of the Board
span multiple presidential and congressional terms. Once a member of the Board of Governors is appointed by the
president, he or she functions mostly independently. Such independence is
unanimously supported by major economists
Membership is by statute limited in term, and a member that has served for a full 14-year term is not eligible for reappointment.
The Chair and Vice Chair of the Board of
Governors are appointed by the President from among the
sitting Governors. They both serve a
four-year term and they can be renominated as many times as the President
chooses, until their terms on the Board of Governors expire.
https://en.wikipedia.org/wiki/Federal_Reserve_Board_of_Governors
The Federal Open Market Committee (FOMC) is
charged under United States law with overseeing the
nation's open market operations (e.g., the Fed's buying and selling
of United States Treasury securities). This Federal Reserve committee
makes key decisions about interest rates and the growth of the United States
money supply.
The FOMC is the principal organ
of United States national monetary policy.
The Committee sets monetary
policy by specifying the short-term objective for the Fed's open market
operations, which is usually a target level for the federal funds
rate (the rate that commercial banks charge between themselves for
overnight loans).
The FOMC also directs operations undertaken by the Federal Reserve System
in foreign exchange markets, although any intervention in foreign
exchange markets is coordinated with the U.S. Treasury, which has
responsibility for formulating U.S. policies regarding the exchange value of
the dollar.
The Committee consists
of the seven members of the Federal Reserve Board, the
president of the New York Fed, and four of the other eleven regional Federal
Reserve Bank presidents, serving one year
terms. Four of the Federal Reserve Bank presidents serve one-year terms on a rotating
basis.
By law, the FOMC must meet at least four times each year
in Washington, D.C. Since
1981, eight regularly scheduled
meetings have been held each year at intervals of five to eight weeks.
The FOMC holds eight regularly scheduled
meetings during the year and other meetings as needed. Links to policy
statements and minutes are in the calendars below. The minutes of
regularly scheduled meetings are released three weeks after the date of
the policy decision.
Federal open market committee meeting calendars, minutes and
statement (2013-2018)
………
August
27 (notation vote)
Longer-Run Goals and Policy Strategy
September
15-16*
Statement:
PDF | HTML
Implementation Note
Press Conference
Projection
Materials
PDF | HTML
Minutes:
PDF | HTML
(Released October 07, 2020)
November
4-5
Statement:
PDF | HTML
Implementation Note
December
15-16*
* Meeting associated with a Summary of Economic Projections.
There
are 12 regional Federal Reserve Banks, not to be confused with the "member banks", with
25 branches, which serve as the operating arms of the system. Each Federal
Reserve Bank is subject to oversight by the Board of Governors. Each Federal Reserve Bank has a board
of directors, whose members work closely with their Reserve Bank president to
provide grassroots economic information and input on management and monetary
policy decisions. These boards are drawn from the general public and the
banking community and oversee the activities of the organization. They also
appoint the presidents of the Reserve Banks, subject to the approval of the
Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises
and the public (nonbankers) and three as representatives of banking. Each Federal Reserve branch office has
its own board of directors, composed of three to seven members, that provides
vital information concerning the regional economy.
Map of the twelve Federal Reserve Districts, with the twelve Federal Reserve Banks marked as black squares, and all Branches within each district (24 total) marked as red circles. The Washington DC Headquarters is marked with a star. (Also, a 25th branch in Buffalo, NY had been closed in 2008.)
https://en.wikipedia.org/wiki/Structure_of_the_Federal_Reserve_System
Jacksonville
Branch Directors https://www.frbatlanta.org/about/atlantafed/directors/jacksonville
Member
Banks
Each
member bank is a private bank (e.g., a privately owned corporation) that holds stock in one
of the twelve regional Federal Reserve banks. The amount of stock each member bank must buy is set to be equal to
3% of its combined capital and surplus of stock in the Reserve Bank
within its region of the Federal Reserve System. All of the commercial banks
in the United States can be divided into three types according to which
governmental body charters them and whether or not they are members of the
Federal Reserve System.
Type |
Definition |
national banks |
Those chartered by the federal government (through the
Office of the Comptroller of the Currency in the Department of the
Treasury); by law, they are members of the Federal Reserve System |
state member banks |
Those chartered by the states who are members of the Federal
Reserve System. |
state nonmember banks |
Those chartered by the states who are not members of the
Federal Reserve System. |
All nationally chartered banks hold stock in
one of the Federal Reserve banks. State-chartered banks may choose to be
members (and hold stock in a regional Federal Reserve bank), upon meeting
certain standards.
Member
banks receive a fixed, 6% dividend annually on their stock, and they do not directly control the
applicable Federal Reserve bank as a result of owning this stock. They do, however, elect six of the nine
members of Reserve banks' boards of directors
Other banks may elect to become member
banks. According to the Federal Reserve Bank of Boston:
Any state-chartered bank (mutual or
stock-formed) may become a member of the Federal Reserve System.
Outline
Organization
of the Federal Reserve System
Whole
·
The
nation's central bank
·
A
regional structure with 12 districts
·
Subject
to general Congressional authority and oversight
·
Operates
on its own earnings
Board of Governors
·
Seven
members serving staggered 14-year terms
·
Appointed
by the U.S. President and confirmed by the Senate
·
Oversees
System operations, makes regulatory
decisions, and sets reserve requirements
·
The System's
key monetary policymaking body
·
Decisions seek
to foster economic growth with price stability by influencing the flow of
money and credit
·
Composed of
the seven members of the Board of Governors and five Reserve Bank presidents,
one of whom is the president of the Federal Reserve Bank of New York, the
other presidents serve as voting members for one-year terms on a rotating
basis.
·
12 regional banks with 25 branches
·
Each
independently incorporated with a nine-member board of directors, with six of
them elected by the member banks while the remaining three are designated by
the Board of Governors.
·
Set
discount rate, subject to approval by Board of Governors.
·
Monitor
economy and financial institutions in their districts and provide financial
services to the U.S. government and depository institutions.
Member banks
·
Private
banks
·
Hold
stock in their local Federal Reserve Bank
·
Elect
six of the nine members of Reserve Banks' boards of directors.
Advisory Committees
·
Carry
out varied responsibilities
https://en.wikipedia.org/wiki/Structure_of_the_Federal_Reserve_System
FEDERAL RESERVE statistical release
H.4.1
Factors Affecting Reserve Balances of Depository
Institutions and Condition Statement of Federal Reserve Banks |
November 5, 2020 |
https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab9
For class discussion: The
security holding has increased in the following balance sheet. Why? Does it
has an impact on interest rate?
5. Consolidated Statement of Condition of All Federal
Reserve Banks
Millions of dollars
Assets, liabilities, and capital |
Eliminations from consolidation |
Wednesday |
Change since |
|
Wednesday |
Wednesday |
|||
Oct 28, 2020 |
Nov 6, 2019 |
|||
Assets |
||||
Gold certificate account |
11,037 |
0 |
0 |
|
Special drawing rights certificate account |
5,200 |
0 |
0 |
|
Coin |
1,481 |
+ 3 |
- 193 |
|
Securities,
unamortized premiums and discounts, repurchase agreements, and loans |
6,945,910 |
+ 8,962 |
+2,974,463 |
|
Securities held outright1 |
6,540,758 |
+ 10,919 |
+2,898,317 |
|
U.S. Treasury securities |
4,538,087 |
+ 10,901 |
+2,343,769 |
|
Bills2 |
326,044 |
0 |
+ 260,034 |
|
Notes and bonds, nominal2 |
3,872,732 |
+ 9,469 |
+1,891,737 |
|
Notes and bonds, inflation-indexed2 |
297,163 |
+ 1,201 |
+ 174,392 |
|
Inflation compensation3 |
42,148 |
+ 230 |
+ 17,606 |
|
Federal agency debt securities2 |
2,347 |
0 |
0 |
|
Mortgage-backed securities4 |
2,000,324 |
+ 19 |
+ 554,548 |
|
Unamortized premiums on securities held outright5 |
339,163 |
+ 927 |
+ 212,559 |
|
Unamortized discounts on securities held outright5 |
-4,672 |
- 83 |
+ 8,109 |
|
Repurchase agreements6 |
1,000 |
0 |
- 214,160 |
|
Loans7 |
69,660 |
- 2,802 |
+ 69,638 |
|
Net
portfolio holdings of Commercial Paper Funding Facility II LLC8 |
8,559 |
- 17 |
+ 8,559 |
|
Net portfolio holdings of Corporate Credit Facilities
LLC8 |
45,663 |
+ 186 |
+ 45,663 |
|
Net
portfolio holdings of MS Facilities LLC (Main Street Lending Program)8 |
41,683 |
+ 410 |
+ 41,683 |
|
Net portfolio holdings of Municipal Liquidity Facility
LLC8 |
16,552 |
+ 1 |
+ 16,552 |
|
Net portfolio holdings of TALF II LLC8 |
12,266 |
+ 503 |
+ 12,266 |
|
Items in process of collection |
(0) |
53 |
- 6 |
- 23 |
Bank premises |
2,190 |
- 9 |
+ 4 |
|
Central bank liquidity swaps9 |
7,248 |
+ 449 |
+ 7,202 |
|
Foreign currency denominated assets10 |
21,644 |
- 28 |
+ 1,037 |
|
Other assets11 |
37,993 |
+ 719 |
+ 10,822 |
|
Total assets |
(0) |
7,157,479 |
+ 11,173 |
+3,118,036 |
Note: Components may not sum to totals because of rounding.
Footnotes appear at the end of the table.
5. Consolidated Statement of Condition of All Federal
Reserve Banks (continued)
Millions of dollars
Assets, liabilities, and capital |
Eliminations from consolidation |
Wednesday |
Change since |
|
Wednesday |
Wednesday |
|||
Oct 28, 2020 |
Nov 6, 2019 |
|||
Liabilities |
||||
Federal Reserve notes, net of F.R. Bank holdings |
2,001,134 |
+ 5,087 |
+ 264,399 |
|
Reverse repurchase agreements12 |
193,037 |
- 8,856 |
- 95,459 |
|
Deposits |
(0) |
4,799,036 |
+ 12,932 |
+2,830,255 |
Term deposits held by depository institutions |
0 |
0 |
0 |
|
Other deposits held by depository institutions |
2,979,537 |
+ 32,281 |
+1,450,780 |
|
U.S. Treasury, General Account |
1,618,568 |
- 34,471 |
+1,240,384 |
|
Foreign official |
21,264 |
+ 13 |
+ 16,081 |
|
Other13 |
(0) |
179,666 |
+ 15,108 |
+ 123,009 |
Deferred availability cash items |
(0) |
155 |
- 661 |
- 43 |
Treasury contributions to credit facilities14 |
114,000 |
0 |
+ 114,000 |
|
Other liabilities and accrued dividends15 |
10,895 |
+ 2,673 |
+ 4,979 |
|
Total liabilities |
(0) |
7,118,258 |
+ 11,176 |
+3,118,132 |
Capital accounts |
||||
Capital paid in |
32,396 |
- 3 |
- 97 |
|
Surplus |
6,825 |
0 |
0 |
|
Other capital accounts |
0 |
0 |
0 |
|
Total capital |
39,221 |
- 3 |
- 97 |
Homework (due with final)
1.
What is the FOMC? How many members? How many times does FOMC meet
each year? What is determined at the FOMC meeting?
2.
What is the reserve bank? In our area, where is the reserve bank located?
3.
What is the board of governor of the Fed? How many members? Who is
the chair?
4.
What is the role of Fed?
5.
Is the Fed a private or a public entity?
http://www.federalreserve.gov/releases/h41/20071129/
Fed Balance Sheet as of Nov 29th, 2007
(At that time, Fed assets = 882,848)
http://www.federalreserve.gov/releases/h41/20081128/
Fed Balance Sheet as of Nov 28th, 2008
http://www.federalreserve.gov/releases/h41/20091127/
Fed Balance Sheet as of Nov 27th, 2009
http://www.federalreserve.gov/releases/h41/20101126/
Fed Balance Sheet as of Nov 26th, 2010
http://www.federalreserve.gov/releases/h41/20111125/
Fed Balance Sheet as of Nov 25th, 2011
https://www.federalreserve.gov/releases/h41/20121129/
Fed Balance Sheet as of Nov 29th, 2012
Fed Balance Sheet as of Nov 29th, 2013
https://www.federalreserve.gov/releases/h41/20141128/
Fed Balance Sheet as of Nov 28th, 2014
Fed Balance Sheet as of Nov 27th, 2015
https://www.federalreserve.gov/releases/h41/20161125/
Fed Balance Sheet as of Nov 25th, 2016
https://www.federalreserve.gov/releases/h41/20171124/
Fed Balance Sheet as of Nov 24th, 2017
Open market operation (video)
https://www.youtube.com/watch?v=FNq_C4h3Srk
The Tools of Monetary Policy
Part
II: Monetary Policy
The Fed Explains Monetary
Policy (video)
The Tools of Monetary
Policy (video)
Central banks have three
main monetary policy tools:
open market operations (target fed
funds rate), the discount rate, and the reserve requirement. Most central
banks also have a lot more tools at their disposal.
Open market
operations are
when central banks buy or sell securities. These are bought
from or sold to the country's private banks. When the central bank buys
securities, it adds cash to the banks' reserves. That gives them more money
to lend. When the central bank sells the securities, it places them on the
banks' balance sheets and reduces its cash holdings. The bank now has less to
lend. A central bank buys securities when it wants expansionary
monetary policy. It sells them when it
executes contractionary monetary policy.
The reserve requirement refers to the money banks must keep on
hand overnight. They can either keep the reserve in their vaults or at
the central bank. A low reserve requirement allows banks to lend more of their deposits. It's
expansionary because it creates credit.
A high reserve requirement
is contractionary. It gives banks less money to lend. It's especially hard
for small banks since they don't have as much to lend in the first
place. That's why most central banks don't impose a reserve requirement
on small banks. Central banks rarely change the reserve requirement
because it's difficult for member banks to modify their procedures.
The discount rate is the third tool. It's the rate that
central banks charge its members to borrow at its discount window. Since
it's higher than the fed funds rate, banks only use this if they can't borrow
funds from other banks.
Using the discount window also has a
stigma attached. The financial community assumes that any bank that uses the
discount window is in trouble. Only a desperate bank that's been rejected by
others would use the discount window
Central banks
often hold three major monetary tools
for managing money supply. These are:
These tools can either help
expand or contract economic growth.
Monetary policies are aimed
to control:
Aside from the three traditional monetary tools, the Federal
Reserve possesses new, innovative ones, most of which were contrived to cope
with the 2008 recession.
https://www.thebalance.com/monetary-policy-tools-how-they-work-3306129
Tight,
or contractionary monetary
policy is a course of action undertaken by a central bank such
as the Federal Reserve to slow down overheated economic growth, to
constrict spending in an economy that is seen to be accelerating too quickly,
or to curb inflation when it is rising too fast.
The
central bank tightens policy or makes money tight by raising short-term
interest rates through policy changes to the discount rate, also known as the
federal funds rate. Boosting interest rates increases the cost of borrowing
and effectively reduces its attractiveness. Tight monetary policy can also be
implemented via selling assets on the central bank's balance sheet to the
market through open market operations (OMO).
In a tightening
policy environment, the Fed can also
sell Treasuries on the open market in order to absorb
some extra capital during a tightened monetary policy environment. This
effectively takes capital out of the open markets as the Fed takes in funds
from the sale with the promise of paying the amount back with interest.
In a
tightening monetary policy environment, a reduction in the money supply is a
factor that can significantly help to slow or keep the domestic currency from
inflation. The Fed often looks at tightening monetary policy during
times of strong economic growth.
An easing monetary policy environment
serves the opposite purpose. In an easing policy environment, the central
bank lowers rates to stimulate growth in the economy. Lower rates lead
consumers to borrow more, also effectively increasing the money supply.
Many
global economies have lowered their federal funds rates to zero, and some
global economies are in negative rate environments. Both zero and negative
rate environments benefit the economy through easier borrowing. In an extreme
negative rate environment, borrowers even receive interest payments, which
can create a significant demand for credit.
https://www.investopedia.com/terms/t/tightmonetarypolicy.asp
Central banks most often use the federal
funds rate as a leading tool for regulating
market factors.
Federal funds rate is the target interest
rate set by the Federal Open Market Committee (FOMC) at which commercial
banks borrow and lend their excess reserves to each other overnight. The Federal Open Market Committee (FOMC),
the monetary policy-making body of the Federal Reserve System, meets
eight times a year to set the federal funds rate.
The federal funds rate
refers to the interest rate that banks charge other banks for lending to them
excess cash from their reserve balances on an overnight basis.
By law, banks must maintain a reserve equal to a certain percentage of their
deposits in an account at a Federal Reserve bank. The amount of money a bank
must keep in its Fed account is known as a reserve requirement and
is based on a percentage of the bank's total deposits
They are required to
maintain non-interest-bearing accounts at Federal Reserve banks to
ensure that they will have enough money to cover depositors' withdrawals and
other obligations. Any money in their reserve that exceeds the required level
is available for lending to other banks that might have a shortfall.
The
end-of-the-day balances in the bank's account, averaged over two-week reserve maintenance
periods, are used to determine whether it meets
its reserve requirements. If a bank expects to have end-of-the-day balances greater
than what's required, it can lend the excess amount to an institution that
anticipates a shortfall in its balances. The interest rate the lending bank
can charge is the federal funds rate, or fed funds rate.
https://www.investopedia.com/terms/f/federalfundsrate.asp
The discount
rate refers to the interest rate charged to the commercial banks and
other financial institutions for the loans they take from the Federal Reserve
Bank through the discount window loan process.
While commercial banks are free to borrow and
loan capital among each other without the need of any collateral using the
market-driven interbank
rate, they
can also borrow the money for their short term operating requirements from
the Federal Reserve Bank.
Such loans are served by the 12 regional branches of the Fed, and the
loaned capital is used by the financial institutes to fulfill any funding
shortfalls, to prevent any potential liquidity problems or, in the worst-case
scenario, to prevent a bank’s failure. This special
Fed-offered lending facility is known as the discount window. Such loans are granted by the regulatory agency for
an ultra-short-term period of 24-hours or less, and the applicable rate of
interest charged on these loans is a standard discount
rate. This discount rate is not a market rate,
rather it is administered and set by the boards of the Federal Reserve
Bank and is approved by its Board of Governors.
Borrowing institutions use this facility
sparingly, mostly when they cannot find willing lenders in the marketplace.
The Fed-offered discount rates are available at relatively higher interest
rates as compared to the interbank borrowing rates, and discount loans are
intended to be available as an emergency option for banks in distress.
Borrowing from the Fed discount window can even signal weakness to other
market participants and investors. Its use peaks during periods of financial
distress. https://www.investopedia.com/terms/d/discountrate.asp
Segment 406: Open Market
Operations (video of Philadelphia Fed)
Money supply and demand impacting interest rates | Macroeconomics | Khan Academy (video)
Open market operations (OMO) refers to when the Federal Reserve buys and sells primarily U.S. Treasury securities on the open market
in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to
loan out to businesses and consumers. It purchases Treasury securities to
increase the supply of money and sells them to reduce the supply of money.
By
using this system of open market purchasing, the Federal Reserve can produce
the target federal funds rate it has set by providing or else taking
liquidity to commercial banks by buying or selling government bonds with
them. The objective of OMOs is to manipulate the short-term interest rate and
the supply of base money in an economy.
The Federal Open Market Committee (FOMC) is the entity that carries the
Federal Reserve's OMO policy. The Board of Governors of the Federal Reserve sets a
target federal funds rate and then the FOMC implements the open market
operations that achieve that rate. https://www.investopedia.com/terms/o/openmarketoperations.asp
Prime rate, federal funds rate, COFIUPDATED: 11/17/2020 |
|||
THIS WEEK |
MONTH AGO |
YEAR AGO |
|
Fed Funds Rate (Current target rate 0.00-0.25) |
0.25 |
0.25 |
1.75 |
What it means: The
interest rate at which banks and other depository institutions lend money to
each other, usually on an overnight basis. The law requires banks to keep a
certain percentage of their customer's money on reserve, where the banks earn
no interest on it. Consequently, banks try to stay as close to the reserve
limit as possible without going under it, lending money back and forth to
maintain the proper level.
How it's used: Like
the federal discount rate, the federal funds rate is used to control the
supply of available funds and hence, inflation and other interest rates.
Raising the rate makes it more expensive to borrow. That lowers the supply of
available money, which increases the short-term interest rates and helps keep
inflation in check. Lowering the rate has the opposite effect, bringing
short-term interest rates down.
Interest
on Required Reserve Balances and Excess Balances
http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
The
interest rate on required reserves (IORR rate) is determined by the Board and
is intended to eliminate effectively the implicit tax that reserve
requirements used to impose on depository institutions. The interest rate on
excess reserves (IOER rate) is also determined by the Board and gives the
Federal Reserve an additional tool for the conduct of monetary policy.
According to the Policy Normalization Principles and Plans adopted
by the Federal Open Market Committee (FOMC), during monetary policy
normalization, the Federal Reserve intends to move the federal funds rate
into the target range set by the FOMC primarily by adjusting the IOER
rate. For the current setting of the IOER rate, see the most
recent implementation note issued by the FOMC. This note provides
the operational settings for the policy tools that support the FOMC’s target
range for the federal funds rate.
The
Board will continue to evaluate the appropriate settings of the interest
rates on reserve balances in light of evolving market conditions and will
make adjustments as needed.
The
interest rates on reserve balances that are set forth in the table below are
determined by the Board and officially announced in the most recent
implementation note. The table is generally updated each business day at 4:30
p.m., Eastern Time, with the next business day's rates. This table will not
be published on federal holidays.
Interest Rates on Reserve Balances for
November 19, 2020 |
Rates |
Effective |
Rate on Required Reserves (IORR rate) |
0.10 |
03/16/2020 |
Rate on Excess Reserves (IOER rate) |
0.10 |
03/16/2020 |
What is discount rate?
http://www.frbdiscountwindow.org/currentdiscountrates.cfm?hdrID=20&dtlID= (Discount
window borrowing rate)
Current Discount Rates
District |
Primary Credit Rate |
Secondary Credit Rate |
Effective Date |
Boston |
0.25% |
0.75% |
03-16-2020 |
New York |
0.25% |
0.75% |
03-16-2020 |
Philadelphia |
0.25% |
0.75% |
03-16-2020 |
Cleveland |
0.25% |
0.75% |
03-16-2020 |
Richmond |
0.25% |
0.75% |
03-16-2020 |
Atlanta |
0.25% |
0.75% |
03-16-2020 |
Chicago |
0.25% |
0.75% |
03-16-2020 |
St. Louis |
0.25% |
0.75% |
03-16-2020 |
Minneapolis |
0.25% |
0.75% |
03-16-2020 |
Kansas City |
0.25% |
0.75% |
03-16-2020 |
Dallas |
0.25% |
0.75% |
03-16-2020 |
San Francisco |
0.25% |
0.75% |
03-16-2020 |
No Homework assignment.
Please find time to work on term project which is due on the final date.
How the Fed Has Responded to the
COVID-19 Pandemic (FYI)
Wednesday, August
12, 2020
By Jane Ihrig, Senior Adviser, and Gretchen Weinbach,
Senior Associate Director, Federal Reserve Board of Governors, and Scott Wolla, Economic Education Coordinator,
Federal Reserve Bank of St. Louis
The
Federal Reserve’s (or Fed’s) mission is shaped by its mandate to
promote maximum employment and stable
prices for the American people, along with its
responsibilities to promote stability of the financial system. So when the
economy faces a crisis, as it has with the COVID-19 pandemic, the Fed takes
forceful actions to minimize economic harm and set the stage for recovery
when the worst is over.
The
pandemic is causing tremendous human and economic hardship around the world.
What kind of economic damage is it doing? Among other things, the COVID-19
crisis has triggered steep job losses and disrupted financial markets.
Understanding the Federal Reserve’s Actions in Response to
COVID-19
The
Fed’s actions in response to the COVID-19 shock can be grouped into three
categories:
1. Lowering the policy rate and keeping it low
2. Stabilizing financial markets
3. Supporting the flow of credit in the economy
#1 - Lowering the Policy Rate and Keeping it
Low
First,
the Fed’s monetary policymaking body—the Federal Open Market Committee
(FOMC)—quickly lowered the target range for the federal funds rate. The
federal funds rate, which serves as the FOMC’s policy interest rate, is the
rate banks charge each other for overnight loans. During two unscheduled
meetings on March 3 and March
15, the FOMC voted to reduce the target range for the federal
funds rate by a total of 1½ percentage points, dropping it to near zero. The
graph below shows the rapid decline.
In
addition, starting with its March 15 statement, the FOMC has indicated that
it expects to keep the policy rate at that level until the economy has
weathered recent events and is on track to meet the Fed’s dual mandate.
Movements in the policy rate influence other interest rates in the economy,
such as those for home and car loans.
These
steps have helped make borrowing costs low for households and businesses at a
critical time. They are also intended to spur spending and investment when
the economy emerges from the depths of the crisis.
#2 - Stabilizing Financial Markets
Second,
the Fed took a number of steps to unfreeze key financial markets and to help
them run smoothly. For example, trading conditions in the market for U.S.
Treasury securities, which is critical to the overall functioning of the
financial system, showed severe strains in early and mid-March. In other
words, the prices of these securities were very volatile and it was difficult
for sellers to find sufficient buyers. (For more discussion of these
conditions, see the Fed’s May 2020 Financial
Stability Report and a July 2020 speech
by Lorie Logan, an executive vice president at the New York Fed.)
The
blue shaded region of the graph below shows how quickly the Fed ramped up its
purchases of Treasury securities—it bought around $1.7 trillion worth between
mid-March and the end of June. The Fed also increased its purchases of
mortgage-backed securities, as shown in green.
In
general, the Fed’s purchases of securities keep markets working when assets
are otherwise difficult to sell. The purchases also inject cash into the
economy, and convey to the public that the Fed stands ready to backstop
important parts of the financial system.
#3 – Supporting the Flow of Credit in the
Economy
Third,
to support the flow of credit to businesses, households and communities where
it was not otherwise available, the Fed introduced several temporary lending
and funding facilities. These facilities are formal financial assistance
programs offered by the Fed to help eligible borrowers with funding needs.
The Fed is authorized to use these lending—not spending—powers only in
special circumstances and with the approval of the Treasury secretary.
You
may have heard these kinds of emergency measures referred to as “13(3)”
facilities. That’s because the Fed’s authority for these measures comes from
Section 13(3) of the Federal Reserve Act.
Overall,
the Fed has introduced multiple temporary facilities to support various types
of funding and credit markets, as well as businesses of all sizes.
Two
of the commonly discussed facilities are:
(For
more information on all of the facilities, see the Fed’s Monetary
Policy Report from June and Funding,
Credit, Liquidity and Loan Facilities on the Board of
Governors site.)
Setting the Stage for Economic Recovery
While
primarily a health crisis, the COVID-19 pandemic has also significantly
disrupted the U.S. economy and financial markets. In line with its mission,
the Fed responded forcefully. During the initial several weeks of the crisis,
the Fed used its interest rate policy to support the economy, took steps to
stabilize financial markets, and introduced other measures to support the
flow of credit to many sectors of the economy.
These
actions help minimize harm to the economy and also set the stage for economic
recovery when the public health crisis has sufficiently subsided.
Additional Resources
https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic
Final will be posted on blackboard under course introduction
on 11/21, Noncumulative, 50 T/F Questions
All
homework due; term
project
due, with final
Happy Holidays
Happy Holidays